PAULA FINANCIAL, 424B1, 1997-10-28

PAULA FINANCIAL
424B1, 1997-10-28
FIRE, MARINE & CASUALTY INSURANCE

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<PAGE>
As filed pursuant to
Rule 424(b)(1)
Registration No. 333-33159

[PAULA
2,500,000 SHARES
LOGO]
PAULA FINANCIAL
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
--------------

Of the 2,500,000 shares of Common Stock offered hereby, 2,212,814 shares are
being sold by the Company and 287,186 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders". The Company will not
receive any of the proceeds from the sale of the shares being sold by the
Selling Stockholders.

Prior to this offering, there has been no public market for the Common Stock
of the Company. For factors to be considered in determining the initial public
offering price, see "Underwriting".

SEE "RISK FACTORS" ON PAGE 11 FOR CERTAIN CONSIDERATIONS RELEVANT TO AN
INVESTMENT IN THE COMMON STOCK.

The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "PFCO".
----------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

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

<TABLE>
<CAPTION>
INITIAL PUBLIC UNDERWRITING PROCEEDS TO PROCEEDS TO
OFFERING PRICE DISCOUNT(1) COMPANY(2) SELLING STOCKHOLDERS
-------------- ------------- -------------- --------------------
<S> <C> <C> <C> <C>
Per Share......................... $18.50 $1.30 $17.20 $17.20
Total (3)......................... $46,250,000 $3,250,000 $38,060,401 $4,939,599
</TABLE>

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

(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.

(2) Before deducting estimated expenses of $872,387 payable by the Company.

(3) The Company and the Selling Stockholders have granted the Underwriters an
option for 30 days to purchase up to an additional 375,000 shares at the
initial public offering price per share, less the underwriting discount,
solely to cover over-allotments. If such option is exercised in full, the
total initial public offering price, underwriting discount, proceeds to
Company and proceeds to Selling Stockholders will be $53,187,500,
$3,737,500, $41,285,401 and $8,164,599, respectively. See "Underwriting".

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

The shares offered hereby are offered severally by the Underwriters, as
specified herein, subject to receipt and acceptance by them and subject to their
right to reject any order in whole or in part. It is expected that certificates
for the shares will be ready for delivery in New York, New York, on or about
October 29, 1997, against payment therefor in immediately available funds.

GOLDMAN, SACHS & CO. CONNING & COMPANY
----------

The date of this Prospectus is October 23, 1997.
<PAGE>
A map of the United States depicting the states and communities where the
Company has operations and is licensed for business. Several photographs of
agribusiness settings and Company personnel will accompany the map and an
indication of the location of the depicted areas will appear by connecting the
photographs to areas on the map. A topic sentence will accompany the graphic,
"PAULA has 50 years of experience providing employee benefits to agribusiness
communities in the West."

[photo/map]

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

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE
OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".

2
<PAGE>
AVAILABLE INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C., a Registration Statement on Form S-1 under the
Securities Act of 1933, as amended (the "Securities Act"), with respect to the
common stock, par value $.01 per share (the "Common Stock"), of the Company
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement and the exhibits and schedules thereto. For
further information with respect to the Company and such Common Stock, reference
is hereby made to such Registration Statement and the exhibits and schedules
thereto. Statements contained in this Prospectus as to the contents of any
contract or any other document are not necessarily complete, and in each
instance reference is made to the copy of such contract or document filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respects by such reference. The Registration Statement, including the
exhibits and schedules thereto, may be inspected and copied at the public
reference facilities maintained by the Commission at its principal office
located at 450 Fifth Street, N.W., Washington, D.C. 20549, the New York Regional
Office located at 7 World Trade Center, 13th Floor, New York, New York 10048,
and the Chicago Regional Office located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of such material can be
obtained from the Public Reference Section of the Commission, at 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates and from the
Commission's website at http://www.sec.gov.

The Company intends to furnish its stockholders with annual reports
containing audited financial statements examined and reported upon by
independent certified public accountants and with quarterly reports containing
unaudited interim financial information for each of the first three fiscal
quarters of each fiscal year.

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

PAULA FINANCIAL OWNS ALL OF THE CAPITAL STOCK OF PAULA INSURANCE COMPANY
("PICO") AND PAULA ASSURANCE COMPANY ("PACO"). BOTH PICO AND PACO ARE INSURANCE
COMPANIES DOMICILED IN THE STATE OF CALIFORNIA. THE INSURANCE LAWS OF CALIFORNIA
PROVIDE THAT NO PERSON MAY ACQUIRE CONTROL OF AN INSURANCE COMPANY DOMICILED IN
THE STATE OF CALIFORNIA UNLESS SUCH PERSON HAS RECEIVED THE APPROVAL OF THE
CALIFORNIA DEPARTMENT OF INSURANCE (THE "CALIFORNIA DOI") OR THE CALIFORNIA DOI
DOES NOT DISAPPROVE THE ACQUISITION WITHIN 60 DAYS AFTER AN APPLICATION HAS BEEN
FILED. ANY PERSON WHO, DIRECTLY OR INDIRECTLY, OWNS, HOLDS THE POWER TO VOTE,
HOLDS PROXIES REPRESENTING OR OTHERWISE CONTROLS 10% OR MORE OF THE OUTSTANDING
VOTING SECURITIES OF AN INSURANCE COMPANY DOMICILED IN CALIFORNIA OR ITS HOLDING
COMPANY IS PRESUMED TO "CONTROL" THE INSURANCE COMPANY UNLESS THE CALIFORNIA
DOI, UPON APPLICATION, DETERMINES OTHERWISE. ACCORDINGLY, ANY PERSON WHO
PURCHASES IN THIS OFFERING SHARES OF THE COMPANY'S COMMON STOCK WHICH, WHEN
COMBINED WITH ALL OTHER VOTING SECURITIES OWNED OR OTHERWISE CONTROLLED BY THAT
PERSON, TOTAL 10% OR MORE OF THE VOTING SECURITIES OF THE COMPANY WILL BE DEEMED
TO HAVE ACQUIRED CONTROL OF PICO AND PACO, UNLESS THE CALIFORNIA DOI DETERMINES
OTHERWISE. SEE "RISK FACTORS--ANTI-TAKEOVER CONSIDERATIONS".

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

FOR NORTH CAROLINA INVESTORS: THE COMMISSIONER OF INSURANCE OF NORTH
CAROLINA HAS NOT APPROVED OR DISAPPROVED THIS OFFERING, NOR HAS THE COMMISSIONER
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.

3
<PAGE>
PROSPECTUS SUMMARY

THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE DETAILED
INFORMATION AND FINANCIAL STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. ON
SEPTEMBER 23, 1997, PAULA FINANCIAL, WHICH FORMERLY WAS DOMICILED IN CALIFORNIA,
EFFECTED A REINCORPORATION IN THE STATE OF DELAWARE PURSUANT TO WHICH IT MERGED
WITH AND INTO A WHOLLY-OWNED DELAWARE SUBSIDIARY FORMED SOLELY FOR PURPOSES OF
THE REINCORPORATION. THE TERM "COMPANY" MEANS PAULA FINANCIAL, A DELAWARE
CORPORATION, ITS CONSOLIDATED SUBSIDIARIES AND ITS PREDECESSORS, AFTER GIVING
EFFECT TO THE REINCORPORATION. ALL SHARE AND PER SHARE DATA INCLUDED HEREIN HAVE
BEEN RESTATED TO GIVE EFFECT TO A TWO-FOR-ONE STOCK SPLIT OF THE COMMON STOCK
EFFECTED IN THE FORM OF A STOCK DIVIDEND DECLARED ON SEPTEMBER 30, 1997. "PICO"
REFERS TO THE COMPANY'S WORKERS' COMPENSATION INSURANCE SUBSIDIARY, PAULA
INSURANCE COMPANY. THE TERM "PAN AM" MEANS THE COMPANY'S THREE PRINCIPAL
INSURANCE AGENCY SUBSIDIARIES COLLECTIVELY UNLESS THE CONTEXT OTHERWISE
REQUIRES. SEE "GLOSSARY OF SELECTED INSURANCE TERMS" ON PAGE G-1 FOR DEFINITIONS
OF CERTAIN INSURANCE TERMS USED IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED,
THE INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITERS' OVER-ALLOTMENT
OPTION WILL NOT BE EXERCISED. SEE "UNDERWRITING". ALL FINANCIAL INFORMATION
REGARDING THE COMPANY IN THIS PROSPECTUS IS PRESENTED ON THE BASIS OF GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES ("GAAP"), EXCEPT AS OTHERWISE INDICATED.
STATUTORY DATA INCLUDED HEREIN HAS BEEN DERIVED FROM THE ANNUAL AND QUARTERLY
STATEMENTS OF THE COMPANY'S INSURANCE SUBSIDIARIES AS FILED WITH INSURANCE
REGULATORY AUTHORITIES AND PREPARED IN ACCORDANCE WITH STATUTORY ACCOUNTING
PRACTICES ("SAP"). MANAGEMENT BELIEVES THAT SAP DATA ENHANCES AN INVESTOR'S
UNDERSTANDING OF THE COMPANY'S PERFORMANCE BECAUSE THE INSURANCE INDUSTRY
BENCHMARKS TO WHICH THE COMPANY COMPARES ITS PERFORMANCE HEREIN ARE AVAILABLE
ONLY ON A SAP BASIS. INVESTORS SHOULD CONSIDER THAT SAP DIFFERS FROM GAAP IN THE
TREATMENT OF POLICYHOLDER DIVIDENDS, TAXES AND CERTAIN ASSETS AND EXPENSES, AND
THAT SAP IMPOSES MINIMUM LOSS RESERVES. SEE NOTE 10 OF NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS. INVESTORS SHOULD NOTE THAT THE ITEMS EXCLUDED FROM SAP
DATA ARE SIGNIFICANT COMPONENTS IN UNDERSTANDING AND ASSESSING THE COMPANY'S
FINANCIAL PERFORMANCE AND CAUSE THE COMPANY'S GAAP AND SAP DATA TO DIFFER. SAP
DATA SHOULD NOT BE CONSTRUED BY INVESTORS AS AN ALTERNATIVE TO OPERATING INCOME
OR CASH FLOWS AS DETERMINED IN ACCORDANCE WITH GAAP.

THE COMPANY

The Company is a California-based specialty underwriter and distributor of
commercial insurance products which, through its subsidiary PICO, is one of the
largest underwriters specializing in workers' compensation insurance products
and services for the agribusiness industry. The Company began operations in 1946
as an insurance agency providing workers' compensation and group medical
employee benefits to agribusiness employers in underserved rural markets. In
1974, PICO was formed to underwrite the workers' compensation portion of the
business distributed by Pan Am, the Company's insurance agency. In late 1994,
the Company added to its management team and its board of directors and embarked
on a strategy of growth, including expansion into new states, while maintaining
its focus on the agribusiness market.

For the six months ended June 30, 1997, the Company had $45.9 million of
premiums written, compared to $27.7 million for the comparable period in 1996,
an increase of 65.3%. For the years ended December 31, 1996, 1995 and 1994, the
Company had premiums written of $63.6 million, $46.8 million and $53.6 million,
respectively. The Company's primary geographic markets are California, Arizona,
and Oregon, which accounted for approximately 67.8%, 13.6% and 12.0%,
respectively, of premiums written for the six months ended June 30, 1997. Since
1995, the Company has commenced operations in Idaho, Texas, Florida and Alaska
and has been licensed in New Mexico.

4
<PAGE>
("A.M. Best"); Best's Insurance Reports, Property/Casualty, 1997 edition).
Neither the WCIRB nor A.M. Best publishes industry data on a GAAP basis. The
Company's adjusted net stockholders' equity per share has grown at a compound
annual growth rate of 19.3% from January 1, 1981 to June 30, 1997 (21.5% over
the 10 years ended June 30, 1997).

The Company's primary insurance subsidiary, PICO, is currently rated "A-
(Excellent)" by A.M. Best. As of June 30, 1997, the Company had total assets of
$168.5 million and net stockholders' equity of $77.9 million (both on a pro
forma basis after giving effect to the offering and other adjustments described
under "Capitalization"). As of June 30, 1997, 92.7% of the Company's investment
portfolio was invested in fixed maturity securities, all of which were rated "A"
or better by Standard & Poor's Corporation ("S&P"), Moody's Investors Service,
Inc. ("Moody's") or Fitch Investors Service, Inc. ("Fitch") as of such date. The
Company's other principal subsidiaries include PAULA Assurance Company ("PACO"),
a life and health carrier, and Pan Pacific Benefit Administrators, Inc. ("Pan
Pacific"), a third party administrator. The Company's address is 300 North Lake
Avenue, Suite 300, Pasadena, California 91101, and its telephone number is (626)
304-0401.

BUSINESS STRATEGY

The Company believes that its differentiated approach as a provider of
insurance services to the agribusiness industry and its expertise with immigrant
employee groups, partial year workforces and businesses in rural communities
have been critical to its success. The Company views its key strengths as: (i)
its integrated distribution and underwriting activities; (ii) the distinctive
labor relations and cost containment services it provides; and (iii) its
underwriting and risk management expertise with respect to agribusiness risks.
The Company intends to leverage these strengths to grow profitably while
maintaining a reputation as a premier provider of high quality insurance
products and services to small- and medium-sized agribusiness employers. PICO's
book of business, as measured by Estimated Annual Premium ("EAP"), has grown
from $49.3 million as of June 30, 1996 to $77.6 million as of June 30, 1997, an
increase of 57.5%. The Company's growth has been achieved without the
acquisition of other insurance companies.

The Company plans to grow its workers' compensation insurance business
further by: (i) expanding the Company's agribusiness franchise outside of
California and Arizona; (ii) increasing the Company's penetration of rural
communities within California and Arizona; and (iii) expanding into other
industries whose risk characteristics and service requirements are similar to
those of agribusiness. The Company intends to support its growth strategy by
continuing to affiliate with well-regarded, rural-focused insurance agencies and
by developing additional relationships with trade associations and safety
groups.

The Company's target agribusiness market includes those employers who farm,
harvest, transport, pack and process tree fruit, vegetables, fiber, flowers,
vine fruit and dairy products. Labor intensive agribusiness employers rely on
their workforces performing to maximum productivity in order to deliver their
fresh product to market at the best price. Agribusiness insurance risks are
generally characterized by: (i) monolingual Spanish speaking workforces; (ii)
moving work sites and a relative lack of machinery and equipment, making loss
control engineering more difficult; (iii) large seasonal fluctuations and high
turnover in the employee pool, making timely and frequent safety training more
critical and increasing the opportunity for filing fraudulent claims; (iv) fewer
opportunities for discounts from health providers in rural locations; and (v) a
relatively young workforce performing physically demanding labor for low hourly
or piece-work wages. The Company's knowledge of these risk characteristics has
enabled the Company to help its clients satisfy the benefits needs of their
workforces and assisted it to achieve underwriting profitability.

INTEGRATED DISTRIBUTION

5
<PAGE>
the business distributed by Pan Am. The Company believes that Pan Am's direct
interest in the Company's success results in a cooperative relationship among
the agent, the underwriter, loss control consultants, claims management
personnel and the customer and its employees. Pan Am, which has 17 locations in
California, Oregon and Arizona, is the largest distributor for PICO, accounting
for 46.4% of PICO's premiums written for the six months ended June 30, 1997.

To enhance the Company's presence in rural areas not served by Pan Am, the
Company affiliates with insurance agencies of similar size and operating
histories to Pan Am. In late 1996 and early 1997, the Company made minority
equity investments aggregating $1.9 million in two regional commercial insurance
agencies, James G. Parker Insurance Associates ("Parker"), headquartered in
Fresno, California, and CAPAX Management and Insurance Services ("CAPAX"),
headquartered in Modesto, California. In 1996, the Company, Parker and CAPAX
formed the PAULA Trading Company (the "PTC") to affiliate with other independent
agencies. Typically, PTC member agencies have extensive operating histories, a
significant commercial insurance presence in rural communities and historically
high client persistency rates. As of June 30, 1997, ten agencies, including
Parker and CAPAX, have affiliated with the PTC. Pan Am and the other PTC
agencies together distributed 70.8% of PICO's Estimated Annual Premium ("EAP")
as of June 30, 1997. The Company believes that its close relationships with PTC
member agencies assist it in lowering its loss ratio, raising persistency rates
and lowering acquisition costs.

The Company believes it gains significant marketing benefits from the
endorsements Pan Am has developed for the Company. These endorsements by 22
prominent agribusiness trade associations have allowed the Company to be
identified with brand names significant to agribusiness customers. In addition,
they provide the Company with access to large groups of potential customers
without the usual sales process of prospecting individual clients. The Company
believes that solicitation of association members results in a higher percentage
of sales than do individual unaffiliated solicitations.

DISTINCTIVE SERVICES TO AGRIBUSINESS EMPLOYERS

Throughout its history, the Company has tailored its labor relations and
cost containment services to the unique needs of the agribusiness employer. From
the initial reporting of a claim to the careful explanation of benefits to the
medical treatment delivery to the return of an employee to work, the Company's
capabilities are field-based, bilingual, cross-cultural and sensitive to the
unique fraud-prevention and cost-containment issues present in agribusiness. The
Company's safety training, early return to work efforts, case management and
case settlement operations are tailored specifically to the labor relations and
cost containment needs of agribusiness employers and to the needs of Hispanic
and other immigrant laborers.

The Company's field representatives, Special Investigation Unit and claims
staff are central to the Company's service culture. Combined, these services
significantly enhance the agribusiness employer's human resource management
capabilities. The Company's field representatives train crew foremen and field
supervisors on safety practices and hold employee safety training for the
Company's clients and their employees. Field representatives also hand deliver
first-time benefit checks and explain benefits in the language of preference of
the claimant, a long-standing and distinctive practice of the Company which it
believes helps to reduce the cost of claims, particularly by reducing the number
of litigated claims. The Company's Special Investigation Unit reviews each claim
for potential fraud as it is reported to the Company rather than only those
claims referred to the unit by claims adjusters after they suspect fraud, as the
Company believes is more typical in the industry. The Company's claims staff is
bilingual, has an average of 13 years of claims experience and typically manages
only 125 open claims per examiner, which the Company believes is lower than the
industry average.

The Company also distinguishes itself in California and Arizona by offering
the option of occupational medical care in Mexico. The Company offers medical
treatment options in Mexico in three approved clinics in Tijuana, Mexicali and
San Luis. The Company believes it is the only carrier to provide this service.

6
<PAGE>
AGRIBUSINESS UNDERWRITING EXPERTISE

The Company underwrites and prices its products with the objective of
earning an underwriting profit. The Company believes that its expertise and long
history serving agribusiness employers assist it in achieving this objective.
Though agribusiness is widely considered to be a "substandard" class of
insurance, the Company has consistently reported underwriting profitability
above industry averages. For the five years ended December 31, 1996, PICO's SAP
combined ratios have averaged 99.6% as compared to workers' compensation
insurance industry averages in California and nationally of 110.3% and 110.4 %,
respectively, for the same time period (source: WCIRB and A.M. Best,
respectively). The Company's in-depth understanding of the risks in its target
market and its ability to price its product appropriately are the keys to these
results.

The Company's proprietary loss experience database, its trade association
endorsements and its understanding of the risk management needs of agribusiness
employers are the key elements of its underwriting capabilities. The Company's
rate-making process benefits significantly from more than 50 years of claim
experience in the agribusiness industry and a proprietary database built over 23
years. This experience has enabled the Company to differentiate risks by
creating more than 35 farm classes and subclasses, reflecting the unique
characteristics of job classifications and differences in farming operations. In
comparison, the WCIRB publishes only 15 payroll classifications in its schedule
of farm rating reports.

The Company enjoys the endorsement of 22 prominent agribusiness trade
associations and has promoted the formation and operation of 40 other safety
groups. This helps the Company to achieve the actuarial benefit of writing
larger pools, to provide safety training and services to small accounts more
efficiently and to promote the selection of good risks and safety practices by
linking the self-interest of each group member.

7
<PAGE>
THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company............................ 2,212,814 shares

Common Stock offered by the Selling Stockholders............... 287,186 shares

Common Stock to be outstanding after the offering (1).......... 6,135,625 shares

Proposed Nasdaq National Market symbol......................... PFCO

Use of proceeds to the Company................................. The net proceeds to be
received by the Company
from the sale of shares of
Common Stock offered hereby
are estimated to be
approximately $37.2
million. Approximately
$21.8 million of such
proceeds will be
contributed to PICO as
capital to strengthen its
capacity to underwrite
insurance, $1.9 million
will be used to purchase
the securities of CAPAX and
Parker held by PICO and
approximately $11.5 million
will be used to repay bank
debt and other notes
payable. The balance of
such proceeds will be used
for general corporate
purposes.
</TABLE>

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

(1) Excludes 780,650 shares of Common Stock reserved for issuance upon exercise
of options outstanding as of June 30, 1997 pursuant to grants to directors,
officers and employees of the Company. Includes 139,481 shares of Common
Stock to be issued upon exercise of warrants to purchase Common Stock and
1,882,354 shares of Common Stock to be issued upon the automatic conversion
of shares of the Series A Preferred Stock, $.01 par value ("Preferred
Stock"), of the Company upon consummation of the offering. See Notes 8 and 9
of the Notes to Consolidated Financial Statements.

RISK FACTORS

Before purchasing shares of the Common Stock offered hereby, prospective
investors should consider carefully, in addition to the other information
contained in this Prospectus, the risks related to or resulting from: the
variability of operating results; significant geographic and industry
concentration; the establishment of loss reserves; highly competitive industry;
expansion strategy; reliance on independent agents; governmental regulations;
holding company structure and restrictions on dividends; importance of
maintaining A.M. Best rating; dependence on key personnel; investment portfolio
exposure to interest rate risk; availability of reinsurance; no prior public
market for common stock; determination of offering price; potential
anti-takeover effect of regulation and certain charter provisions; shares
available for future sale; and immediate and substantial dilution.

8
<PAGE>
SUMMARY FINANCIAL DATA

The summary data presented below under the captions "Income Statement Data"
and "Balance Sheet Data" as of and for each of the years in the five-year period
ended December 31, 1996 and the six month period ended June 30, 1997 are derived
from the consolidated financial statements of the Company, which financial
statements have been audited by KPMG Peat Marwick LLP, independent certified
public accountants. The consolidated financial statements as of December 31,
1995 and 1996 and June 30, 1997 and for each of the years in the three-year
period ended December 31, 1996 and the six month period ended June 30, 1997 and
the report thereon are included elsewhere in this Prospectus. The summary data
presented below under the captions "Income Statement Data" and "Balance Sheet
Data" for the six-month period ended June 30, 1996 are derived from the
unaudited consolidated financial statements of the Company included elsewhere in
this Prospectus and include, in the opinion of management, all adjustments
(consisting only of normal recurring accruals) necessary for a fair presentation
of the information for such periods. The information presented below under the
captions "Adjusted Balance Sheet Data" and "Other Data" is unaudited. The
results of operations for the six months ended June 30, 1997 are not necessarily
indicative of the results to be expected for the full year. The summary
financial data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
("MD&A") and the Consolidated Financial Statements and notes thereto appearing
elsewhere in this Prospectus.

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Premiums written............................ $ 62,658 $ 53,502 $ 53,545 $ 46,762 $ 63,606 $ 27,745 $ 45,871
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Premiums earned:
Workers' compensation..................... $ 47,235 $ 50,857 $ 50,977 $ 44,224 $ 54,563 $ 21,751 $ 41,303
Group medical and life.................... 13,496 163 312 307 941 471 475
Commissions................................. 3,187 3,514 4,299 3,964 4,213 2,061 1,716
Net investment income....................... 4,983 4,495 4,536 4,817 4,701 2,322 2,499
Net realized investment gains............... 1,585 132 -- 37 444 427 --
Other....................................... 784 1,375 1,712 1,569 896 514 347
--------- --------- --------- --------- --------- --------- ---------
Total revenue............................. $ 71,270 $ 60,536 $ 61,836 $ 54,918 $ 65,758 $ 27,546 $ 46,340
Losses and loss adjustment expenses
incurred.................................. 47,238 30,852 28,618 29,363 33,900 13,937 28,447
Dividends provided for policyholders........ 2,647 5,806 6,221 3,438 1,628 620 309
Operating expenses.......................... 16,656 16,838 20,720 22,608 25,480 10,484 14,752
--------- --------- --------- --------- --------- --------- ---------
Total expenses............................ $ 66,541 $ 53,496 $ 55,559 $ 55,409 $ 61,008 $ 25,041 $ 43,508
Income (loss) before taxes.................. 4,729 7,040 6,277 (491) 4,750 2,505 2,832
Income tax expense (benefit)................ 1,236 1,875 1,572 (791) 827 443 538
--------- --------- --------- --------- --------- --------- ---------
Net income................................ $ 3,493 $ 5,165 $ 4,705 $ 300 $ 3,923 $ 2,062 $ 2,294
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Earnings per share (1)...................... $ 0.93 $ 1.37 $ 1.16 $ 0.08 $ 0.95 $ 0.51 $ 0.56
Weighted average shares outstanding (1)..... 3,756 3,756 4,053 3,989 4,123 4,048 4,120
</TABLE>

9
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30, 1997
----------------------------------------------------- -------------------------
AS
1992 1993 1994 1995 1996 ACTUAL(2) ADJUSTED(3)
--------- --------- --------- --------- --------- ----------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Investments (4)......................... $ 79,879 $ 81,737 $ 83,084 $ 83,991 $ 86,792 $ 93,379 $ 119,961
Total assets............................ 104,833 108,898 117,297 118,906 125,127 141,920 168,502
Unpaid losses and loss adjustment
expenses.............................. 66,170 62,629 60,473 57,049 55,720 64,972 64,972
Notes payable........................... 3,966 3,370 4,205 10,824 11,279 11,468 196
Total liabilities....................... 93,058 95,793 90,384 93,301 99,151 113,602 90,558
Preferred stock (convertible and
redeemable)........................... -- -- 18,918 19,501 21,402 22,776 --
Net stockholders' equity................ 11,775 13,105 7,995 6,104 4,574 5,542 77,944
ADJUSTED BALANCE SHEET DATA:
Adjusted net stockholders' equity (5)... $ 41,213 $ 77,944
Adjusted net stockholders' equity per
share (5)............................. $ 10.44 $ 12.70

AS OF AND FOR THE
SIX MONTHS ENDED JUNE 30,
AS OF AND FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------- -------------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- ----------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
PICO AND PACO GAAP RATIOS:
Loss ratio.............................. 77.8% 60.5% 55.8% 65.9% 61.1% 62.7% 68.1%
Expense ratio........................... 23.0 24.4 26.7 32.3 32.1 34.0 28.2
Policyholder dividend ratio............. 4.4 11.4 12.1 7.7 2.9 2.8 0.7
--------- --------- --------- --------- --------- ----------- ------------
Combined ratio........................ 105.2% 96.3% 94.6% 105.9% 96.1% 99.5% 97.0%
--------- --------- --------- --------- --------- ----------- ------------
--------- --------- --------- --------- --------- ----------- ------------
PICO STATUTORY DATA:
Statutory net income.................... $ 1,787 $ 2,079 $ 5,217 $ 3,175 $ 5,051 $ 1,918 $ 2,902
Statutory surplus....................... 21,736 23,085 19,381 25,992 31,135 27,764 31,821
Premiums/surplus........................ 2.1x 2.2x 2.6x 1.7x 1.9x N/A N/A
Loss ratio.............................. 78.1% 66.0% 55.9% 65.9% 61.0% 62.7% 68.1%
Expense ratio........................... 21.8 23.4 25.9 30.9 29.4 28.5 27.2
Policyholder dividend ratio............. 5.2 11.4 12.2 7.8 3.0 2.8 0.7
--------- --------- --------- --------- --------- ----------- ------------
Combined ratio........................ 105.1% 100.8% 94.0% 104.6% 93.4% 94.0% 96.0%
--------- --------- --------- --------- --------- ----------- ------------
--------- --------- --------- --------- --------- ----------- ------------
OTHER DATA:
Industry average statutory combined
ratio (6)............................. 114.9% 109.0% 107.3% 107.6% 113.1% N/A N/A
Number of PICO policies (period-end).... 1,522 1,901 2,227 4,041 6,481 5,245 8,148
Number of Company employees (period-
end).................................. 248 247 272 237 242 228 249
PICO Estimated Annual Premium (7)
(period-end).......................... $ 41,134 $ 44,133 $ 41,929 $ 41,176 $ 61,316 $ 49,296 $ 77,634
</TABLE>

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

(1) See Note 1 of Notes to Consolidated Financial Statements for a description
of the calculation of weighted average shares outstanding and earnings per
share.

(2) Preferred stock and net stockholders' equity as of June 30, 1997 on a pro
forma basis after giving effect to the conversion of Preferred Stock as
discussed in Note 8 of Notes to Consolidated Financial Statements were $0
and $28,318, respectively.

(3) Gives effect to the sale of the 2,212,814 shares offered by the Company
hereby at the initial public offering price of $18.50 per share and the
initial application of the net proceeds therefrom. Also gives effect to the
elimination of the Company's contractual obligation to repurchase shares of
Common Stock of separated employees under the terms of the ESOP and the
issuance of 139,481 shares of Common Stock upon exercise of outstanding
warrants to purchase Common Stock.

(4) Investments as of December 31, 1992 and 1993 are reflected at amortized
cost. As of December 31, 1994, a portion of the portfolio was classified as
held to maturity and was therefore reflected at amortized cost and the
remaining portfolio was shown at market value. Investments as of December
31, 1995 and 1996 are reflected at market value.

(5) Adjusted to reflect (i) the elimination of the Company's contractual
obligation to repurchase shares of Common Stock of separated employees under
the terms of the PAULA Financial and Subsidiaries Employee Stock Ownership
Plan and its companion PAULA Financial and Subsidiaries Employee Stock
Ownership Trust (collectively, the "ESOP"); (ii) the automatic conversion of
the Preferred Stock to Common Stock; and (iii) the exercise of all
outstanding warrants, each of which will be effected upon consummation of
the offering. In applying the described adjustments to years 1992, 1993,
1994, 1995 and 1996, adjusted net stockholders' equity would be $23,118,
$28,131, $38,350, $35,205 and $38,825, respectively, and adjusted net
stockholders' equity per share would be $6.55, $7.97, $8.73, $8.99 and
$9.83, respectively.

(6) National average for workers' compensation insurance companies. Source: A.M.
Best; Best's Insurance Reports, Property/ Casualty, 1997 edition.

(7) "PICO Estimated Annual Premium" means, as of any date, the estimated total
annualized premiums for all policies written by PICO in force on that date,
whether earned prior to or after such date.

10
<PAGE>
RISK FACTORS

INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS, IN ADDITION
TO ALL THE OTHER INFORMATION APPEARING IN THIS PROSPECTUS, IN CONNECTION WITH AN
INVESTMENT IN THE COMMON STOCK. CERTAIN STATEMENTS INCLUDED IN THIS PROSPECTUS,
INCLUDING, WITHOUT LIMITATION, STATEMENTS CONTAINING THE WORDS "BELIEVES",
"ANTICIPATES", "INTENDS", "EXPECTS" AND WORDS OF SIMILAR IMPORT, CONSTITUTE
FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND
UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE THE ACTUAL
RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO BE MATERIALLY DIFFERENT
FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY
SUCH FORWARD-LOOKING STATEMENTS. SUCH FACTORS INCLUDE, AMONG OTHER THINGS, THE
IMPORTANT FACTORS SET FORTH BELOW AND ELSEWHERE IN THIS PROSPECTUS. GIVEN THESE
UNCERTAINTIES, POTENTIAL PURCHASERS OF THE COMMON STOCK OFFERED HEREBY ARE
CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS.

RISKS RELATED TO THE VARIABILITY OF OPERATING RESULTS

The Company operates in a cyclical industry affected by many factors that
may cause fluctuations in its results of operations. The factors that may
adversely affect the operations and profitability of the Company include: the
severity and frequency of claims; government regulations; court decisions and
the judicial climate, which could lead to escalating damage awards; the
incidence of fraudulent claims; competition; general economic and business
conditions and trends; and fluctuations in interest rates and other changes in
the investment environment which affect market prices of the Company's
investments and the income from those investments. Many of these factors are
beyond the control of the Company. The foregoing factors have contributed to
significant, industry-wide year-to-year and quarter-to-quarter fluctuations in
underwriting results and in net income, and could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"MD&A".

In recent years, the Company's results of operations have been significantly
affected by the favorable development of PICO's loss experience. The Company's
income (loss) before taxes in calendar years 1994, 1995 and 1996 was positively
affected by reserve recoveries by PICO of $4.0 million, $3.9 million and $2.6
million, respectively. These reserve recoveries were primarily attributable to
the favorable development of the 1993, 1994 and 1995 accident years. There can
be no assurance that the Company will have any reserve recoveries in future
periods. See "MD&A" and "Business--Losses and Loss Reserves".

SIGNIFICANT GEOGRAPHIC AND INDUSTRY CONCENTRATION

The Company's current business is concentrated geographically, with
approximately 67.8% of its premiums written in the first six months of 1997 in
California, 13.6% in Arizona, and 12.0% in Oregon, and a majority of the
Company's policyholders are in the agriculture industry. Due to the Company's
focus on the agribusiness industry, it is more exposed to the effects of
injuries and diseases more prevalent in this industry, as well as economic
conditions and regulatory changes affecting labor relations in this industry,
than its more diversified competitors. In addition, changes in the nature and
extent of regulation of workers' compensation insurance companies or adverse
economic or other conditions in the Company's geographic area of operations
would have a more severe impact on the Company than on a more diversified
insurance company. See "--Regulation".

RISKS RELATED TO THE ESTABLISHMENT OF LOSS RESERVES

The Company's insurance subsidiaries are required to establish and maintain
reserves to cover their estimated ultimate liability for losses and loss
adjustment expenses ("LAE") with respect to reported claims and claims incurred
but not yet reported as of the end of each accounting period. These reserves do
not represent an exact calculation of liabilities but rather are estimates
involving actuarial projections at a given time of what the Company expects the
ultimate settlement and administration of

11
<PAGE>
claims will cost. These estimates are based on facts and circumstances then
known, predictions of future events, estimates of future trends in claims
frequency and severity and judicial theories of liability, as well as other
factors such as inflation. In addition, because certain workers' compensation
claims may not be fully paid for a number of years, estimating reserves for such
claims can be more difficult and uncertain than estimating reserves in certain
other lines of insurance where the period between occurrence of the claim and
final determination of the loss is shorter.

The establishment of appropriate reserves is an inherently uncertain
process, and there can be no assurance that ultimate losses will not exceed the
Company's loss reserves and have a material adverse effect on the Company's
results of operations and financial condition. If the Company's reserves should
be inadequate, the Company will be required to increase reserves with a
corresponding increase in losses and loss adjustment expenses incurred and
reduction in the Company's net income and stockholders' equity in the period in
which the deficiency is identified. See "MD&A" and "Business--Losses and Loss
Reserves".

HIGHLY COMPETITIVE INDUSTRY

The insurance industry is highly competitive. The Company's competitors
include, among others, insurance companies, specialized provider groups,
in-house or multiple employer benefits administrators, and state insurance
pools. Many of the Company's existing or potential competitors are larger and
have considerably greater financial and other resources than the Company. To the
extent that any of these existing or potential competitors concentrates
increased resources in the Company's specific market segments, increases
commissions paid to producers or offers more or better services or lower premium
rates in any of the Company's market segments, the Company could be adversely
affected. The Company's largest competitor in its current markets is the state
insurance fund established by each of those states. Changes in marketing
practices by these not-for-profit competitors could adversely affect the
Company's business, financial condition and results of operations. See
"Business-- Competition".

RISKS RELATED TO EXPANSION STRATEGY

Since 1995, the Company has experienced significant growth in its revenues,
policyholders and scope of operations. This growth has required and will
continue to require the Company to obtain additional capital, primarily to
capitalize PICO, its principal insurance subsidiary. The Company intends to use
a significant portion of the net proceeds from this offering to increase the
capital of PICO. If the Company is unable to generate sufficient capital, either
internally or from outside sources, it could be required to reduce its growth.
The Company intends to pursue further growth opportunities through greater
penetration in existing markets and expansion into new jurisdictions. As the
Company expands, the Company will be underwriting policies for insureds in
industries and geographic areas less familiar to the Company. The Company's
workers' compensation insurance experience has been developed over many years
primarily in the agribusiness industry in California and Arizona and, more
recently, in Oregon, and there can be no assurance that this experience will
enable the Company to compete successfully in these new markets or underwrite or
price risks in these markets appropriately. In addition, the Company may rely to
a greater extent on third party providers for assistance in adjusting claims and
various administrative matters in its new markets. The Company's growth has also
resulted in, and is expected to continue to create, new and increased
responsibilities for management personnel, as well as additional demands on the
Company's operating and financial systems. The Company's future growth will
depend on the efforts of key management personnel and the Company's ability to
attract and retain qualified persons, to enhance managerial systems for its
operations, and to successfully integrate new employees and systems into its
existing operations. If the Company is unable to continue to manage growth
effectively, the Company's business, financial condition and results of
operations could be materially adversely affected. See "MD&A" and
"Business--Business Strategy".

12
<PAGE>
RELIANCE ON INDEPENDENT AGENTS

The Company markets its workers' compensation products and services through
Pan Am, and, like other companies in its industry, through independent agents.
For the six months ended June 30, 1997, independent agents (including members of
the PTC other than Pan Am) accounted for approximately 53.6% of PICO's premiums
written. These agents are not obligated to promote the Company's products and
services and may sell competitors' insurance products. As a result, the
Company's business depends in part on the marketing effort of these agents and
on the Company's ability to continue to offer workers' compensation products and
services that meet the requirements of these agents and their customers. In
addition, as the Company expands into additional states and industries, it
expects to establish relationships with additional independent agents. Failure
of these independent insurance agents to market successfully the Company's
products and services could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--
Distribution".

RISKS RELATED TO GOVERNMENTAL REGULATIONS

The Company and its insurance subsidiaries, as California-domiciled
insurers, are subject to extensive regulation by the California DOI, and by
departments of insurance in Alaska, Arizona, Florida, Idaho, New Mexico, Oregon
and Texas. The Company and its subsidiaries will also become subject to
regulation in each additional jurisdiction in which they become licensed to
transact business. Such regulation is primarily for the protection of
policyholders rather than stockholders and could limit the Company's ability to
react to changes in its marketplace or take advantage of new opportunities in a
timely manner. Changes in such regulation could materially and adversely effect
the Company's operations and financial condition. The nature and extent of such
regulation varies from jurisdiction to jurisdiction, but typically involves: (i)
standards of solvency and minimum amounts of capital and surplus which must be
maintained; (ii) limits on types and amounts of investments; (iii) restrictions
on the size of risks which may be insured by a single company; (iv) licensing of
insurers and their agents; (v) required deposits of securities for the benefit
of policyholders; (vi) approval of policy forms; (vii) establishment of
statutory reporting practices and the form and content of statutory financial
statements; (viii) establishment of methods for setting statutory loss and
expense reserves; (ix) review, and in some instances, prior approval of premium
rates; (x) limits on transactions among insurers and their affiliates; (xi)
approval of all proposed changes of control; (xii) approval of dividends; (xiii)
setting and collecting guarantee fund assessments; and (xiv) required filing of
annual and other reports with respect to the financial condition and operation
of insurers. In addition, state regulatory examiners perform periodic financial
and underwriting examinations of insurers. State insurance regulation is
intended for the benefit and protection of policyholders and claimants under
insurance policies, rather than stockholders.

In recent years, the insurance regulatory framework has been subject to
increased scrutiny by the National Association of Insurance Commissioners (the
"NAIC"), state legislatures and insurance regulators and the United States
Congress. The NAIC is a voluntary organization of state regulators. Its
principal mission is to encourage uniformity in state regulation of insurance
through the drafting of model laws and the continuing refinement of insurance
accounting practices and reporting procedures. None of the NAIC's pronouncements
has any legal effect unless enacted by individual states. The NAIC is currently
engaged in a project to codify statutory accounting practices that is likely to
change the definition of what constitutes prescribed versus permitted statutory
accounting practices and may result in changes to the accounting policies that
insurance enterprises use to prepare their statutory financial statements. At
this time, the Company is unable to predict how such project may affect its
insurance subsidiaries' statutory financial statements or how insurance rating
agencies will interpret or react to any such changes. No assurance can be given
that future legislative or regulatory changes resulting from such activities
will not adversely affect the Company and its subsidiaries. See
"Business--Regulation".

13
<PAGE>
RISKS RELATED TO HOLDING COMPANY STRUCTURE AND RESTRICTIONS ON DIVIDENDS

As a holding company with no significant business operations of its own,
PAULA Financial relies on dividends from its subsidiaries, which are primarily
domiciled in California, as the principal source of cash to meet its
obligations, including the payment of principal and interest on its debt
obligations and the payment of dividends to holders of its capital stock.
California law places significant restrictions on the ability of the Company's
insurance company subsidiaries to pay dividends to PAULA Financial. In
particular, all dividends from PICO and PACO, as California-domiciled insurers,
require prior notice to the California DOI. All "extraordinary" dividends must
be approved in advance by the California DOI. A dividend is deemed
"extraordinary" if, when aggregated with all other dividends paid within the
preceding twelve months, the dividend exceeds the greater of (i) PICO's
statutory net income or PACO's statutory net gain from operations (both
excluding unrealized capital gains) for the preceding calendar year or (ii) 10%
of policyholder surplus as of the preceding December 31st. Additionally, unless
approved in advance by the California DOI, no dividend may be paid by PICO or
PACO except from earned surplus. The California DOI may disallow the payment of
any dividend if, in the California DOI's opinion, the payment would in any way
violate the California Insurance Code or be hazardous to policyholders,
creditors or the public. Based on these limitations and statutory results, as of
December 31, 1996, PAULA Financial would be able to receive $5.4 million in
dividends in 1997 from its direct insurance subsidiaries without obtaining prior
regulatory approval from the California DOI. There can be no assurance that
dividends will be declared by PAULA Financial or its subsidiaries in the future
or that any required approvals for payment of dividends by the Company's
insurance subsidiaries will be obtained from the applicable state insurance
departments. See "Dividend Policy" and "Business-- Regulation".

IMPORTANCE OF MAINTAINING A.M. BEST RATING

Ratings are an important factor in communicating the claims paying ability
and financial strength of insurance companies. PICO, the Company's principal
insurance subsidiary, is currently assigned a letter rating of "A- (Excellent)"
from A.M. Best, the leading national insurance rating agency. A.M. Best ratings
range from "A++ (Superior)" to "F (in liquidation)". The "A- (Excellent)" rating
is assigned to companies that, in the opinion of A.M. Best, have demonstrated
excellent overall financial condition and operating performance when compared to
the quantitative and qualitative standards established by A.M. Best. A.M. Best
considers "A-(Excellent)" rated companies to have a strong ability to meet their
obligations to policyholders over a long period of time. A.M. Best ratings are
based on a comparative analysis of the financial condition and operating
performance of insurance companies as determined by their publicly available
reports and meetings with such companies' officers. A.M. Best's ratings are
based on factors considered to be of concern to insureds and are not directed
toward the protection of investors and should not be relied upon by an investor
in making a decision to invest in shares of Common Stock offered hereby. A.M.
Best reviews its ratings periodically and there can be no assurance that PICO's
current rating will be maintained in the future. The Company believes that the
absence of a rating, or an unfavorable rating, is a competitive disadvantage
because certain potential clients will not purchase coverage from unrated or
lower rated companies and certain independent insurance agencies will not place
coverage with such companies. A downgrade in PICO's rating by A.M. Best could
have a material adverse effect on the Company's business, financial condition
and results of operations.

DEPENDENCE ON KEY PERSONNEL

The Company's success is largely dependent on the efforts of a number of key
employees, including Jeffrey Snider, its Chairman of the Board, President, and
Chief Executive Officer, Andrew Slavitt, its Chief Operating Officer, James
Nicholson, its Chief Financial Officer, and Victor Gloria, its Senior Vice
President of Claims Administration. See "Management". None of these employees
has a

14
<PAGE>
written employment agreement with the Company. The loss of the services of any
of these key employees could have a material adverse effect on the Company's
business, financial condition and results of operations.

INVESTMENT PORTFOLIO EXPOSURE TO INTEREST RATE RISK

The Company depends upon income from its investment portfolio for a
significant portion of its revenues and earnings. Substantially all of the
Company's investment portfolio is invested in investment-grade, fixed maturity
securities. The market value of these and the Company's other invested assets
fluctuates depending on general economic and market conditions and changes in
prevailing interest rates. In general, the market value of fixed maturity
securities held by the Company increases or decreases in inverse relationship
with fluctuations in interest rates. The Company has chosen not to invest in
interest rate hedges.

RISKS RELATED TO THE AVAILABILTY OF REINSURANCE

Like many workers' compensation insurance companies, the Company uses
reinsurance to reduce its liability on individual claims and to protect against
catastrophic losses. Reinsurance is subject to prevailing market conditions,
both in terms of price, which can affect the Company's profitability, and
availability, which can affect the Company's ability to grow its underwriting
capacity. In addition, reinsurance does not relieve an insurer of direct
liability to policyholders. Accordingly, the Company is subject to the risk that
its reinsurers will not pay amounts owed by them as and when due. Since 1974,
General Reinsurance Corporation ("GenRe") has been the Company's primary
reinsurer. GenRe is currently assigned a letter rating of "A++ (Superior)" by
A.M. Best. No assurance can be given that alternative reinsurance treaties will
be available to the Company in the future or, if available, will be on terms
acceptable to the Company.

NO PRIOR PUBLIC MARKET FOR COMMON STOCK; DETERMINATION OF OFFERING PRICE

Prior to this offering, there has been no public market for the Common Stock
and there can be no assurance that an active trading market will develop or be
sustained following the completion of this offering. The initial public offering
price of the Common Stock offered hereby was determined by negotiations between
the Company and the representatives of the Underwriters and may not be
indicative of the market price of the Common Stock after this offering. See
"Underwriting" for a discussion of the factors considered in determining the
initial public offering price.

POTENTIAL ANTI-TAKEOVER EFFECT OF REGULATION AND CERTAIN CHARTER PROVISIONS

Under the terms of California law governing insurance holding companies, any
person or entity desiring to acquire 10% or more of the Company's outstanding
voting securities is required to obtain prior approval of the California DOI. In
addition, certain other factors may have the effect of deterring, delaying, or
preventing a change in control of the Company without further action by the
stockholders, may discourage bids for the Common Stock at a premium over the
market price of the Common Stock, and may adversely affect the market price of,
and the voting and other rights of the holders of, Common Stock. These include
the absence of cumulative voting, staggered terms for the Company's directors,
the ability of the Company's directors to issue "blank check" preferred stock
and provisions of Delaware law. See "Business--Regulation--Restrictions on
Acquisitions of Control" and "Description of Capital Stock".

SHARES AVAILABLE FOR FUTURE SALE

Upon completion of this offering, the Company will have outstanding
6,135,625 shares of Common Stock (after giving effect to the conversion of the
Preferred Stock into Common Stock and exercise of

15
<PAGE>
outstanding warrants for Common Stock upon the closing of this offering). Of
these shares, the 2,500,000 shares of Common Stock offered hereby will be freely
tradable in the public market without restriction under the Securities Act.
Substantially all of the remaining 3,635,625 shares of outstanding Common Stock
will be eligible for sale in the public market pursuant to Rule 144 under the
Act and approximately 26.4% of such shares, which are held by the Company's
ESOP, may be eligible for resale without compliance with Rule 144 upon the
distribution of such shares to participants in the ESOP upon termination of
employment. The Company, its executive officers and directors, the ESOP and
certain other holders of Common Stock, which in the aggregate will hold
approximately 48.5% of the Common Stock outstanding after the offering, have
agreed that, during the period beginning from the date of this Prospectus and
continuing to and including the date 180 days after the date of this Prospectus,
they will not offer, sell, contract to sell or otherwise dispose of, or, with
certain exceptions, file or cause to be filed with the Commission a registration
statement with respect to, shares of Common Stock (other than, in the case of
the Company, pursuant to employee stock option plans existing on the date of
this Prospectus and, in the case of the ESOP, distributions of shares to
participants in the ESOP upon termination of such participants' employment with
the Company) or any securities of the Company which are substantially similar to
the shares of Common Stock or which are convertible into or exchangeable for
shares of Common Stock or securities which are substantially similar to the
shares of Common Stock without the prior written consent of the representatives
of the Underwriters, except for the shares of Common Stock offered in connection
with the offering. See "Shares Eligible for Future Sale" and "Underwriting".
Sales of substantial amounts of shares of Common Stock (or the prospect of such
sales) could adversely affect the market price of the Common Stock.

IMMEDIATE AND SUBSTANTIAL DILUTION

The initial public offering price is substantially higher than the net
tangible book value per share of Common Stock. Accordingly, purchasers of shares
of Common Stock offered hereby will suffer immediate dilution in pro forma net
tangible book value of $6.07 per share of Common Stock. In addition, an integral
part of the Company's compensation policies has been the granting of employee
stock options. Purchasers of shares of Common Stock offered hereby will incur
additional dilution to the extent outstanding stock options are exercised. See
"Dilution".

16
<PAGE>
USE OF PROCEEDS

The net proceeds to be received by the Company from the sale of the
2,212,814 shares of Common Stock offered by the Company hereby (based on an
initial public offering price per share of $18.50 and after deducting the
underwriting discount and estimated offering expenses payable by the Company)
are estimated to be approximately $37.2 million ($40.4 million if the
Underwriters' over-allotment option is exercised in full). Approximately $21.8
million of such proceeds will be contributed to PICO as capital to strengthen
its capacity to underwrite insurance, $1.9 million will be used to purchase the
securities of CAPAX and Parker held by PICO, approximately $9.5 million will be
used to repay outstanding bank debt bearing interest at a variable rate (7.64%
per annum as of June 30, 1997) and maturing on December 31, 1999 and $2.0
million will be used to repay notes due former stockholders bearing interest at
a weighted average rate, as of June 30, 1997, of 8.25% per annum and maturing on
January 10, 1998 and January 1, 2000. The balance of such proceeds will be used
for general corporate purposes. Pending the Company's application of the
proceeds from this offering, such proceeds will be invested primarily in
investment-grade, fixed maturity securities in accordance with the Company's
normal investment policy.

The Company will not receive any of the proceeds from the sale of the shares
of Common Stock being sold by the Selling Stockholders.

DIVIDEND POLICY

The Company has not paid cash dividends to its stockholders in either of the
two most recent fiscal years. Subject to the declaration by the Board of
Directors, the Company intends to pay a quarterly dividend of $0.04 per share of
Common Stock commencing in the fourth quarter of 1997.

Although the Company currently intends to pay dividends, the declaration and
payment of dividends is subject to the discretion of the Company's Board of
Directors and will depend upon, among other things, the Company's results of
operations, financial condition, cash requirements, future prospects and capital
requirements, regulatory restrictions on the payment of dividends by the
Company's insurance company subsidiaries, general economic and business
conditions and other factors deemed relevant by the Board of Directors. There
can be no assurance that the Company will declare and pay any dividends. The
ability of the Company's subsidiaries to pay dividends to the Company is subject
to substantial regulation. In addition, the Company's line of credit restricts
the payment of dividends under certain circumstances. See "Risk
Factors--Regulation--Holding Company Structure; Restrictions on Dividends",
"MD&A--Liquidity and Capital Resources", "Business--Regulation" and Note 10 of
Notes to Consolidated Financial Statements.

17
<PAGE>
DILUTION

As of June 30, 1997, the pro forma net tangible book value of the Company
(after giving effect to the automatic conversion of the Preferred Stock into
Common Stock, the exercise of all outstanding warrants and elimination of the
Company's obligation to repurchase Common Stock of separated employees under the
terms of the ESOP as a result of this offering as described under
"Capitalization") would have been approximately $39.6 million, or $10.02 per
share. Net tangible book value per share is determined by dividing the tangible
net worth of the Company (tangible assets minus total liabilities) by the number
of shares of Common Stock outstanding. After giving effect to the sale by the
Company of 2,212,814 shares of Common Stock at an initial public offering price
of $18.50 per share, the pro forma net tangible book value of the Company as of
June 30, 1997 (after deducting the underwriting discount and estimated offering
expenses payable by the Company) would have been approximately $76.3 million, or
$12.43 per share. This represents an immediate increase in pro forma net
tangible book value of $2.41 per share to the existing stockholders and an
immediate dilution of $6.07 per share to new investors purchasing shares at the
initial public offering price as illustrated in the following table:

<TABLE>
<S> <C> <C>
Initial public offering price.............................................. $ 18.50
---------
Pro forma net tangible book value per share before offering.............. $ 10.02
Increase per share attributable to new investors......................... 2.41
---------
Pro forma net tangible book value per share after offering................. $ 12.43
---------
Immediate dilution in pro forma net tangible book value per share to new
investors................................................................ $ 6.07
---------
---------
</TABLE>

The following table sets forth, as of June 30, 1997, on a pro forma basis,
the respective positions of the Company's existing stockholders and new
investors with respect to the number of shares purchased from the Company, the
total consideration paid to the Company and the average price paid per share, at
an initial public offering price of $18.50 per share without giving effect to
underwriting discounts and offering expenses payable by the Company.

<TABLE>
<CAPTION>
SHARES PURCHASED CONSIDERATION PAID AVERAGE
------------------------ --------------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
----------- ----------- -------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
New investors...................................... 2,500,000 40.7% $ 46,250,000 73.1% $ 18.50
Existing stockholders.............................. 3,635,625 59.3 17,034,000 26.9 4.69
----------- ----- -------------- -----
Total.......................................... 6,135,625 100.0% $ 63,284,000 100.0%
----------- ----- -------------- -----
----------- ----- -------------- -----
</TABLE>

The information set forth above does not give effect to the potential
exercise of options outstanding as of June 30, 1997 to purchase 780,650 shares
of Common Stock at a weighted average price of $9.01 per share. Purchasers of
shares of Common Stock offered hereby will incur additional dilution to the
extent outstanding stock options are exercised.

18
<PAGE>
CAPITALIZATION

The following table sets forth the capitalization of the Company as of June
30, 1997, and as adjusted to reflect (i) the sale of the shares of Common Stock
offered hereby; (ii) the application of the estimated net proceeds to the
Company of the offering as described under "Use of Proceeds"; (iii) the
elimination upon consummation of the offering of the Company's contractual
obligation to repurchase shares of Common Stock of separated employees under the
terms of the ESOP; (iv) the automatic conversion of the Preferred Stock to
Common Stock upon consummation of the offering; and (v) the exercise of all
outstanding warrants upon consummation of the offering.

<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
-----------------------
ACTUAL AS ADJUSTED
--------- ------------
<S> <C> <C>
(IN THOUSANDS)
Notes payable........................................................................... $ 11,468 $ 196
Obligation on stock held by ESOP (1).................................................... 11,495 --
Preferred Stock, $.01 par value, 5,000,000 shares authorized;
941,177 shares outstanding (0 as adjusted)............................................ 22,776 --

Stockholders' equity:
Common Stock, $.01 par value, 15,000,000 shares authorized;
1,900,976 outstanding (6,135,625 as adjusted) (2)................................... 20 61
Additional paid-in capital............................................................ 1,724 63,139
Retained earnings..................................................................... 16,113 14,078
Net unrealized gain on investments.................................................... 862 862

Less:
Treasury Stock, at cost............................................................... 1,486 --
Guarantee of notes payable of ESOP.................................................... 196 196
Obligation on stock held by ESOP (1).................................................. 11,495 --
--------- ------------
Net stockholders' equity.............................................................. 5,542 $ 77,944
--------- ------------
Total capitalization.............................................................. $ 51,281 $ 78,140
--------- ------------
--------- ------------
</TABLE>

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

(1) Represents the Company's contractual obligation to repurchase shares of
Common Stock of separated employees under the terms of the ESOP. Such
obligation will be eliminated upon consummation of this offering. See Note 9
of Notes to Consolidated Financial Statements.

(2) Excludes 780,650 shares of Common Stock reserved for issuance upon exercise
of options outstanding as of June 30, 1997 pursuant to grants to directors,
officers and employees of the Company. See "Management--Stock Incentive
Plans" and "--Other Management Stock Options". The as adjusted amount
includes 1,882,354 shares of Common Stock to be issued upon automatic
conversion of the Preferred Stock into Common Stock and 139,481 shares of
Common Stock to be issued upon exercise of all outstanding warrants.

19
<PAGE>
SELECTED FINANCIAL DATA

The selected data presented below under the captions "Income Statement Data"
and "Balance Sheet Data" as of and for each of the years in the five-year period
ended December 31, 1996 and the six month period ended June 30, 1997, are
derived from the consolidated financial statements of the Company, which
financial statements have been audited by KPMG Peat Marwick LLP, independent
certified public accountants. The consolidated financial statements as of
December 31, 1995 and 1996 and June 30, 1997 and for each of the years in the
three-year period ended December 31, 1996 and the six month period ended June
30, 1997, and the report thereon are included elsewhere in this Prospectus. The
selected data presented below under the captions "Income Statement Data" and
"Balance Sheet Data" for the six-month period ended June 30, 1996 are derived
from the unaudited consolidated financial statements of the Company included
elsewhere in this Prospectus and include, in the opinion of management, all
adjustments (consisting only of normal recurring accruals) necessary for a fair
presentation of the information for such periods. The information presented
below under the captions "Adjusted Balance Sheet Data" and "Other Data" is
unaudited. The results of operations for the six months ended June 30, 1997 are
not necessarily indicative of the results to be expected for the full year. The
selected financial data set forth below should be read in conjunction with
"MD&A" and the Consolidated Financial Statements and notes thereto appearing
elsewhere in this Prospectus.

20
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30, 1997
---------------------------------------------------------- --------------------------
AS
1992 1993 1994 1995 1996 ACTUAL(2) ADJUSTED(3)
---------- ---------- ---------- ---------- ---------- ----------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Investments (4)....................... $ 79,879 $ 81,737 $ 83,084 $ 83,991 $ 86,792 $ 93,379 $ 119,961
Total assets.......................... 104,833 108,898 117,297 118,906 125,127 141,920 168,502
Unpaid losses and loss adjustment
expenses............................ 66,170 62,629 60,473 57,049 55,720 64,972 64,972
Notes payable......................... 3,966 3,370 4,205 10,824 11,279 11,468 196
Total liabilities..................... 93,058 95,793 90,384 93,301 99,151 113,602 90,558
Preferred Stock (convertible and
redeemable)......................... -- -- 18,918 19,501 21,402 22,776 --
Net stockholders' equity.............. 11,775 13,105 7,995 6,104 4,574 5,542 77,944
ADJUSTED BALANCE SHEET DATA:
Adjusted net stockholders' equity
(5)................................. 41,213 77,944
Adjusted net stockholders' equity per
share (5)........................... $ 10.44 $ 12.70

<CAPTION>
AS OF AND FOR THE
SIX MONTHS ENDED JUNE 30,
AS OF AND FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------- --------------------------
1992 1993 1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ---------- ----------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
PICO AND PACO GAAP RATIOS:
Loss ratio............................ 77.8% 60.5% 55.8% 65.9% 61.1% 62.7% 68.1%
Expense ratio......................... 23.0 24.4 26.7 32.3 32.1 34.0 28.2
Policyholder dividend ratio........... 4.4 11.4 12.1 7.7 2.9 2.8 0.7
---------- ---------- ---------- ---------- ---------- ----------- -------------
Combined ratio...................... 105.2% 96.3% 94.6% 105.9% 96.1% 99.5% 97.0%
---------- ---------- ---------- ---------- ---------- ----------- -------------
---------- ---------- ---------- ---------- ---------- ----------- -------------
PICO STATUTORY DATA:
Statutory net income.................. $ 1,787 $ 2,079 $ 5,217 $ 3,175 $ 5,051 $ 1,918 $ 2,902
Statutory surplus..................... 21,736 23,085 19,381 25,992 31,135 27,764 31,821
Premiums/surplus...................... 2.1x 2.2x 2.6x 1.7x 1.9x N/A N/A

Loss ratio............................ 78.1% 66.0% 55.9% 65.9% 61.0% 62.7% 68.1%
Expense ratio......................... 21.8 23.4 25.9 30.9 29.4 28.5 27.2
Policyholder dividend ratio........... 5.2 11.4 12.2 7.8 3.0 2.8 0.7
---------- ---------- ---------- ---------- ---------- ----------- -------------
Combined ratio...................... 105.1% 100.8% 94.0% 104.6% 93.4% 94.0% 96.0%
---------- ---------- ---------- ---------- ---------- ----------- -------------
---------- ---------- ---------- ---------- ---------- ----------- -------------
OTHER DATA:
Industry average statutory combined
ratio (6)........................... 114.9% 109.0% 107.3% 107.6% 113.1% N/A N/A
Number of PICO policies (period-
end)................................ 1,522 1,901 2,227 4,041 6,481 5,245 8,148
Number of Company employees
(period-end)........................ 248 247 272 237 242 228 249
PICO Estimated Annual Premium (7)
(period-end)........................ $ 41,134 $ 44,133 $ 41,929 $ 41,176 $ 61,316 $ 49,296 $ 77,634
</TABLE>

- --------------------
(1) See Note 1 of Notes to Consolidated Financial Statements for a description
of the calculation of weighted average shares outstanding and earnings per
share.

(2) Preferred Stock and net stockholders' equity as of June 30, 1997 on a pro
forma basis after giving effect to the conversion of Preferred Stock as
discussed in Note 8 of Notes to Consolidated Financial Statements were $0
and $28,318, respectively.

(5) Adjusted to reflect (i) the elimination of the Company's contractual
obligation to repurchase shares of Common Stock of separated employees under
the terms of the ESOP; (ii) the automatic conversion of the Preferred Stock
to Common Stock; and (iii) the exercise of all outstanding warrants, each of
which will be effected upon consummation of the offering. In applying the
described adjustments to years 1992, 1993, 1994, 1995 and 1996, adjusted net
stockholders' equity would be $23,118, $28,131, $38,350, $35,205 and
$38,825, respectively, and adjusted net stockholders' equity per share would
be $6.55, $7.97, $8.73, $8.99 and $9.83, respectively.

(6) National average for workers' compensation insurance companies. Source: A.M.
Best; Best's Insurance Reports, Property/ Casualty, 1997 edition.

(7) "PICO Estimated Annual Premium" means, as of any date, the estimated total
annualized premiums for all policies written by PICO in force on that date,
whether earned prior to or after such date.

21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

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 are the direct premiums earned by the Company on in force
policies, net of reinsurance. 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 components of the Company's revenues are set forth below for the periods
presented:

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Premiums earned

Workers' compensation................................ $ 50,977 $ 44,224 $ 54,563 $ 21,751 $ 41,303

Group medical and life............................... 312 307 941 471 475
--------- --------- --------- --------- ---------

Total premiums earned................................ $ 51,289 $ 44,531 $ 55,504 $ 22,222 $ 41,778

Commissions............................................ 4,299 3,964 4,213 2,061 1,716

Net investment income.................................. 4,536 4,817 4,701 2,322 2,499

Net realized investment gains.......................... -- 37 444 427 --

Other.................................................. 1,712 1,569 896 514 347
--------- --------- --------- --------- ---------

Total revenues....................................... $ 61,836 $ 54,918 $ 65,758 $ 27,546 $ 46,340
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>

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

The Company's results of operations are affected by, among other things, (i)
the amount of the Company's insurance in force, which the Company measures using
EAP; (ii) the Company's ability to select risks in which it is skilled in
underwriting; (iii) its ability to price these risks appropriately; (iv) the

22
<PAGE>
frequency and severity of claims; (v) the cost of acquiring business; (vi) the
cost of providing service and meeting general operating expenses; (vii) net
investment income; (viii) the adequacy of loss reserves for prior year claims;
(ix) the general regulatory and competitive environment; and (x) the capital
structure or leverage of the Company. In addition, 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.

RECENT OPERATING RESULTS

The Company's recent operating results have been affected by additions to
its senior management team, the advent of open rating in California and changes
in California workers' compensation legislation in 1993. In late 1994, the
Company added to its management team and its board of directors and embarked on
a strategy of growth, including expansion into new states, while maintaining its
focus on the agribusiness market. For the six months ended June 30, 1997, the
Company's premiums earned were $41.8 million, an 88.0% increase over premiums
earned of $22.2 million in the comparable 1996 period. For the six month periods
ended June 30, 1997 and 1996, the Company's combined ratio remained relatively
constant at 97.0% and 99.5%, respectively.

The Company's premiums earned depend in part on the amount of PICO's
insurance in force, which the Company measures using EAP, a statistical measure
of insurance business in force at a point in time. Management believes EAP is a
useful measure because EAP, as of any date, represents the estimated total
annualized premiums for all policies in force on that date, whether reflected in
premiums earned prior to that date or to be reflected in premiums earned
thereafter. The extent to which EAP is reflected in future premiums earned
depends, among other things, on the persistency rate of the Company's policies
in force and changes in premium rates at renewal. In evaluating EAP, investors
should consider that EAP is an estimate of insurance premiums to be earned by
the Company in the future which may differ from actual future premiums earned
and, therefore, the Company's EAP is not comparable to the Company's premiums
written or premiums earned. EAP should not be construed by investors as an
alternative to operating income or cash flows as determined in accordance with
GAAP.

PICO's EAP increased from $49.3 million as of June 30, 1996 to $77.6 million
as of June 30, 1997, an increase of 57.5%. The Company's growth has been
achieved without the acquisition of other insurance companies. The following
table sets forth selected information relating to the growth of PICO's workers'
compensation insurance book of business:

<TABLE>
<CAPTION>
AS OF AND FOR THE
AS OF AND FOR THE SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
EAP (period-end)....................................... $ 41,929 $ 41,176 $ 61,316 $ 49,296 $ 77,634
Premiums written....................................... 53,234 46,455 62,665 27,274 45,396
Premiums earned........................................ 50,977 44,224 54,563 21,751 41,303
Policyholder persistency rate.......................... 91.8% 87.8% 86.8% N/A N/A
Number of policies (period-end)........................ 2,227 4,041 6,481 5,245 8,148
</TABLE>

The Company's premiums earned are affected by changes in the competitive and
regulatory environment that impact workers' compensation insurance rates. Prior
to January 1, 1995, California had required workers' compensation insurers to
adhere to minimum rates approved by the California DOI. Under this system, price
competition among insurers had been generally restricted to the payment of
dividends under participating policies. Effective January 1, 1995, this system
was replaced with a file and use rate system, in which insurers may use any rate
after filing it with the California DOI unless such rate is specifically
disapproved. The repeal of the former minimum rate system in California has
resulted in increased competition among workers' compensation insurers in
California and has caused a material decrease in average rates charged by PICO.
According to statistics developed by the WCIRB, California

23
<PAGE>
workers' compensation insurance premiums have declined from a high of
approximately $9.0 billion for 1993 to approximately $5.9 billion for 1995 and
$5.8 billion for 1996. The Company's premiums written declined in 1995 compared
to 1994 as a result of this change in average rates, offset in part by increased
coverage sold by the Company in 1995.

The Company's underwriting results are also affected by its loss experience.
The Company believes that legislation enacted in California in 1993 contributed
to an industry-wide reduction in claims frequency and led to a stabilization of
claims severity, which has helped improve the Company's loss experience. Among
other things, the 1993 legislation: (i) tightened standards relating to
stress-related claims; (ii) limited post-termination claims; (iii) placed
restrictions, including payment limitations, on vocational rehabilitation
claims; (iv) increased measures to reduce fraudulent claims; (v) increased the
ability of insurance companies and employers to contract with managed care
organizations and to direct claimants' medical care; and (vi) changed procedures
for second medical evaluations. The Company believes that the limitation of
post-termination claims was especially beneficial to the Company due to large
seasonal fluctuations and high turnover among farm workers. Due in part to the
effect of these reforms, as well as to PICO's continued improvement in claims
management and management of the medical and legal components of its workers'
compensation claims, PICO experienced favorable development of reserves for the
1993-1995 accident years and recovered reserves of $4.0 million, $3.9 million,
and $2.6 million in calendar years 1994, 1995 and 1996, respectively. PICO
determined reserves for accident years 1993 and 1994, and to a lesser extent,
1995 and 1996, based on the relatively high incurred loss and LAE trends for the
1989 - 1992 accident years. PICO's actual incurred losses and LAE for the 1993 -
1995 accident years proved to be lower than anticipated and PICO's original
reserves for these periods were ultimately redundant. PICO determined its
reserve for recent accident years with the benefit of information indicating
favorable development in the immediately prior accident years. Accordingly,
there can be no assurance that the Company will have any reserve recoveries in
future periods. See "Business--Losses and Loss Reserves".

Workers' compensation policies can be written on a participating or
non-participating basis. Participating policies allow the Company in its
discretion to declare and pay dividends to a policyholder after the expiration
of the policy based upon a policyholder's specific loss experience (or, if the
policyholder is part of a safety group, the group's specific loss experience),
the Company's overall loss experience and competitive conditions. Prior to the
advent of open rating in California, California's workers' compensation insurers
typically charged minimum rates for premiums and used policyholder dividends as
a means of competitive pricing. With the advent of open rating in California and
an emphasis on, among other things, competitive pricing at inception, the
Company's dividends provided for policyholders decreased significantly in 1996,
although the relative mix of the Company's participating and non-participating
policies has remained relatively constant (see Note 1 of the Notes to
Consolidated Financial Statements). Although the Company believes policyholder
dividends are relatively insignificant as an element in workers' compensation in
California, the Company intends to continue to issue participating policies that
are eligible for policyholder dividend consideration in states outside of
California.

PICO's and PACO's operating expenses as a percentage of premiums are an
important component of the Company's profitability. In this regard, the Company
has benefited from recent growth. For the six months ended June 30, 1997, PICO's
and PACO's expense ratio improved 5.8 percentage points from 34.0% for the
comparable 1996 period to 28.2%.

24
<PAGE>
The following table provides information with respect to the Company's
insurance company subsidiaries for the periods presented:

<S> <C> <C> <C> <C> <C>
Premiums written....................................... $ 53,545 $ 46,762 $ 63,606 $ 27,745 $ 45,871
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Premiums earned........................................ $ 51,289 $ 44,531 $ 55,504 $ 22,222 $ 41,778
Losses and loss adjustment expenses incurred........... 28,618 29,363 33,900 13,937 28,447
Dividends provided for policyholders................... 6,221 3,438 1,628 620 309
Underwriting expenses.................................. 13,697 14,367 17,828 7,546 11,769
--------- --------- --------- --------- ---------
Underwriting income (loss)........................... $ 2,753 $ (2,637) $ 2,148 $ 119 $ 1,253
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------

PICO and PACO GAAP ratios:
Loss ratio........................................... 55.8% 65.9% 61.1% 62.7% 68.1%
Expense ratio........................................ 26.7 32.3 32.1 34.0 28.2
Policyholder dividend ratio.......................... 12.1 7.7 2.9 2.8 0.7
--------- --------- --------- --------- ---------
Combined ratio..................................... 94.6% 105.9% 96.1% 99.5% 97.0%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
PICO SAP combined ratio................................ 94.0% 104.6% 93.4% 94.0% 96.0%
Industry average statutory combined ratio(1)........... 107.3 107.6 113.1 N/A N/A
</TABLE>

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

(1) National average for worker's compensation insurance companies. Source: A.M.
Best; Best's Insurance Reports, Property/Casualty, 1997 edition.

Over the five year period ended December 31, 1996, PICO's SAP combined ratio
averaged 99.6%, approximately 10.7 percentage points below the California
average for the workers' compensation insurance industry (source: WCIRB) and
10.8 percentage points below the national average for the workers' compensation
insurance industry (source: A.M. Best; Best's Insurance Reports, Property/
Casualty, 1996 edition). The Company believes its strong underwriting results
have been due in part to its focus on underwriting and pricing insurance
policies with the objective of generating an underwriting profit, its
understanding of the risks in the agribusiness market and its integrated
distribution of products through Pan Am.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996

PREMIUMS WRITTEN. The Company's premiums written for the six months ended
June 30, 1997 increased 65.3% to $45.9 million from $27.7 million for the
comparable 1996 period. The growth in premiums written was primarily
attributable to the net addition of new policyholders and increased policyholder
payrolls, partially offset by lower premium rates resulting from increased price
competition.

PREMIUMS EARNED. For the reasons described above for premiums written, the
Company's premiums earned for the six months ended June 30, 1997 increased 88.0%
to $41.8 million from $22.2 million for the comparable 1996 period.

COMMISSION INCOME. Commission income decreased 16.7% to $1.7 million for
the six months ended June 30, 1997 from $2.1 million for the comparable 1996
period. The decrease was primarily the result of decreased premiums placed with
carriers other than PICO and PACO, a result of the Company's decision to focus
on writing PICO workers' compensation insurance. Commission income is earned on
premiums placed with carriers other than PICO and PACO. Commission income paid
by PICO and PACO to Pan Am are eliminated in consolidation.

25
<PAGE>
NET INVESTMENT INCOME. Net investment income increased 7.6% to $2.5 million
for the six months ended June 30, 1997 from $2.3 million for the comparable 1996
period. The increase was the result of significant cash flow increases from
PICO's underwriting activity. Average invested assets increased to $88.8 million
for the six months ended June 30, 1997 from $82.4 million for the comparable
period in 1996. The Company's average yield on its portfolio was 5.6% in both
periods.

NET REALIZED INVESTMENT GAINS. The Company had no net realized investment
gains for the six months ended June 30, 1997 compared to $0.4 million for the
comparable 1996 period.

OTHER INCOME. Other income decreased 32.5% to $0.3 million for the six
months ended June 30, 1997 from $0.5 million for the comparable period in 1996
primarily as a result of decreased third party administration fees following the
termination of a large third party administration contract in early 1996.

LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED. The Company's loss ratio for
the six months ended June 30, 1997 increased to 68.1% from 62.7% for the
comparable 1996 period. The Company's loss ratio for the six months ended June
30, 1996 was positively impacted by net recoveries from loss and loss adjustment
expense reserves for prior years of $2.9 million compared with a positive impact
of net recoveries from prior years of $0.8 million for the comparable 1997
period.

DIVIDENDS PROVIDED FOR POLICYHOLDERS. Dividends provided for policyholders
decreased 50.2% to $0.3 million for the six months ended June 30, 1997 from $0.6
million for the comparable 1996 period and decreased as a percentage of premiums
earned for the six months ended June 30, 1997 to 0.7% from 2.8% for the
comparable 1996 period. With the advent of open rating in California and an
emphasis on, among other things, competitive pricing at inception, the Company's
dividends provided for policyholders decreased significantly commencing in late
1995.

OPERATING EXPENSES. Operating expenses increased 40.7% to $14.8 million for
the six months ended June 30, 1997 from $10.5 million for the comparable 1996
period due in part to a $1.9 million increase in commissions paid to
unaffiliated agencies.

INCOME TAXES. Income tax expense for the six months ended June 30, 1997
increased to $0.5 million from $0.4 million for the six months ended June 30,
1996. The effective combined income tax rates for the six months ended June 30,
1997 and June 30, 1996 were 19.0% and 17.7%, respectively. These rates are below
the combined statutory rate due to the significant portion of the Company's
investment portfolio consisting of tax-exempt securities.

1996 COMPARED TO 1995

PREMIUMS WRITTEN. The Company's premiums written for 1996 increased 36.0%
to $63.6 million from $46.8 million for 1995. The increase was primarily
attributable to an increase in PICO's California writings of $11.4 million (an
increase of 39.8%) principally from newly-appointed independent agencies and the
establishment of the PTC, net of California reductions due to increased price
competition, and an increase of PICO's Oregon writings of $4.8 million (an
increase of 104.3%).

PREMIUMS EARNED. For the reasons described above for premiums written, the
Company's premiums earned for 1996 increased 24.6% to $55.5 million from $44.5
million for 1995.

COMMISSION INCOME. Commission income increased 6.3% to $4.2 million for
1996 from $4.0 million for 1995.

NET INVESTMENT INCOME. Net investment income decreased 2.4% to $4.7 million
for 1996 from $4.8 million for 1995. The Company's average yield on its
portfolio was 5.6% for 1996 compared to 5.8% for 1995, reflecting generally
lower market interest rates in 1996 compared to 1995. Average invested assets
increased $0.7 million to $83.6 million in 1996 from $82.9 million in 1995.

NET REALIZED INVESTMENT GAINS. During 1996, the Company sold $17.2 million
of its invested assets and realized $0.4 million of investment gains. There were
no material investment gains realized in

26
<PAGE>
1995. During 1996, the Company repositioned $7.0 million of its portfolio into
AAA-rated agency-backed collateralized mortgage obligations to increase yield.

OTHER INCOME. Other income decreased 42.9% to $0.9 million for 1996 from
$1.6 million for 1995, primarily as a result of the termination of a large third
party administration client contract in early 1996 which was matched with a
comparable reduction in expenses.

LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED. The Company's loss ratio for
1996 improved to 61.1% from 65.9% for 1995. The improvement in this ratio is due
to several factors, including a reduction in the incidence and severity of
workers' compensation claims and the expedited closing of claims. Losses for
1996 include the effect of recoveries from prior years' reserves of $2.6
million, or 4.8% of 1996 premiums earned, compared with prior year recoveries of
$3.9 million for 1995, or 8.8% of 1995 premiums earned. The Company believes its
loss experience was improved by overall trends in the industry due to regulatory
reforms, a reduction and capitation of the Company's claims related legal
expenses, the implementation of early return to work programs by the Company's
clients and an aggressive program by the Company to combat workers' compensation
insurance fraud.

DIVIDENDS PROVIDED FOR POLICYHOLDERS. Dividends provided for policyholders
decreased to $1.6 million in 1996 from $3.4 million in 1995 and decreased as a
percentage of premiums earned for 1996 to 2.9% from 7.7% for 1995. With the
advent of open rating in California and an emphasis on, among other things,
competitive pricing at inception, the Company's dividends provided for
policyholders decreased significantly commencing in late 1995.

OPERATING EXPENSES. Operating expenses increased 12.7% to $25.5 million for
1996 from $22.6 million for 1995 due in part to a $2.2 million increase in
commissions paid to unaffiliated agencies.

INCOME TAXES. Income tax expense for 1996 was $0.8 million compared to a
$0.8 million tax recovery for 1995. The effective combined income tax rate for
1996 was 17.4%. These rates are below the combined statutory rate due to the
significant portion of the Company's investment portfolio consisting of
tax-exempt securities.

1995 COMPARED TO 1994

PREMIUMS WRITTEN. The Company's premiums written for 1995 decreased 12.7%
to $46.8 million from $53.5 million for 1994. The decrease was primarily
attributable to a 29.7% decrease in PICO's California writings as a result of
the introduction of open rating effective January 1, 1995 and the related price
competition in the California marketplace. This reduction was offset in part by
increased writings in the Company's Arizona market in 1995 of 5.6% and $4.6
million of new premiums written in the Oregon market in 1995. During the initial
phases of open rating the Company chose to focus on smaller accounts and not to
aggressively compete for large account business which it perceived to be more
subject to price competition. The Company did not commence writing insurance in
Oregon until January 1, 1995.

PREMIUMS EARNED. For the reasons described above for premiums written, the
Company's premiums earned for 1995 decreased 13.2% to $44.5 million from $51.3
million for 1994.

COMMISSION INCOME. Commission income decreased 7.8% to $4.0 million for
1995 from $4.3 million for 1994.

NET INVESTMENT INCOME. Net investment income increased 6.2% to $4.8 million
for 1995 from $4.5 million for 1994. The Company's average yield on its
portfolio was 5.8% for 1995 and 5.5% for 1994. There was no significant change
in average invested assets between 1995 and 1994.

NET REALIZED INVESTMENT GAINS. There were no material realized capital
gains for 1995 or 1994.

OTHER INCOME. There was no material change in the amount of other income
from 1994 to 1995.

LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED. The loss ratio for 1995 was
65.9% compared to 55.8% in 1994. The 1995 loss ratio increase was primarily
attributable to a decline in average premium

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rates in California as a result of open rating, which began in 1995. Losses for
1995 include the effect of recoveries from prior years' reserves of $3.9
million, or 8.8% of 1995 premiums earned, compared with prior year recoveries of
$4.0 million in 1994, or 7.9% of 1994 premiums earned. The reduction of prior
year reserves in 1995 and 1994 was due to favorable development as a result of
regulatory reform in California and an aggressive program by the industry to
combat workers' compensation insurance fraud.

DIVIDENDS PROVIDED FOR POLICYHOLDERS. Dividends provided for policyholders
decreased $2.8 million to $3.4 million for 1995 from $6.2 million for 1994 as a
result of open rating in California and decreased as a percentage of premiums
earned for 1995 to 7.7% from 12.1% for 1994. The 1995 dividend accrual included
additional dividend accruals of $0.9 million for the 1993 and 1994 policy years.

OPERATING EXPENSES. Operating expenses increased 9.1% to $22.6 million for
1995 from $20.7 million for 1994 primarily due to an increase in commissions and
commission rebates paid to third parties.

INCOME TAXES. The Company recorded an income tax benefit of $0.8 million
for 1995 compared to income tax expense of $1.6 million for 1994. The effective
combined income tax rate for 1994 was 25.0%. This rate is below the combined
statutory rate due to the significant portion of the Company's investment
portfolio consisting of tax-exempt securities.

LIQUIDITY AND CAPITAL RESOURCES

THE PARENT COMPANY

As a holding company, PAULA Financial's principal sources of funds are
dividends and expense reimbursements from its operating subsidiaries, proceeds
from loans, 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, following the completion of this offering, dividends
to its stockholders. In the past, PAULA Financial has also used substantial
amounts of capital to repurchase its Common Stock from stockholders upon their
separation from employment. As of June 30, 1997, the primary obligations of the
Company were $9.4 million principal amount of borrowings under the Company's
$15.0 million revolving credit agreement (the "Credit Agreement"), $1.9 million
principal amount of notes due to former stockholders incurred to repurchase
their Common Stock and a liability of $11.5 million representing the Company's
commitments to repurchase Common Stock under the terms of the ESOP. Upon
consummation of the offering, the Company's obligation to the ESOP will be
eliminated and the Company will repay approximately $9.5 million in principal
and interest under the Credit Agreement and approximately $2.0 million of
principal and interest on stockholder notes.

California law places significant restrictions on the ability of the
insurance subsidiaries to pay dividends to PAULA Financial. All dividends from
PICO and PACO, as California-domiciled insurers, require prior notice to the
California DOI. All "extraordinary" dividends must be approved in advance by the
California DOI. A dividend is deemed "extraordinary" if, when aggregated with
all other dividends paid within the preceding twelve months, the dividend
exceeds the greater of (i) PICO's statutory net income or PACO's statutory net
gain from operations (both excluding unrealized capital gains) for the preceding
calendar year or (ii) 10% of policyholder surplus as of the preceding December
31st. Additionally, unless approved in advance by the California DOI, no
dividend may be paid by PICO or PACO except from earned surplus. Dividends paid
from earned surplus which do not exceed the definition of "extraordinary" must
be reported to the California DOI within five business days after declaration.
Insurers are prohibited from paying such dividends until ten business days after
the California DOI's receipt of such notice. The California DOI may disallow
payment of any dividend if, in the California DOI's opinion, the payment would
in any way violate the California Insurance Code or be hazardous to
policyholders, creditors or the public. Based on these limitations and statutory
results, as of December 31, 1996, PAULA Financial would be able to receive $5.4
million in dividends in 1997 from its insurance subsidiaries without obtaining
prior regulatory approval from the California DOI.

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The Company expects to retain approximately $2.0 million from the proceeds
of the offering at the parent company level. Management believes that this cash,
funds available under the Credit Agreement and expense reimbursements and
dividends from its operating subsidiaries will be sufficient to meet the parent
company's operating cash needs for at least three years.

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. Borrowings under the Credit Agreement bear interest at variable interest
rates. The Credit Agreement limits the Company's ability to (i) enter new lines
of business; (ii) incur or assume debt; (iii) pay dividends and repurchase or
retire capital stock upon a default or event of default; and (iv) make
acquisitions, investments and capital expenditures. The Credit Agreement
contains financial covenants with respect to minimum stockholders' equity,
minimum statutory surplus, a ratio of debt to stockholders' equity, a ratio of
PICO's premiums written to statutory surplus and excess statutory reserves, a
debt service coverage ratio, A.M. Best rating and risk-based capital levels.
Each of PAULA Financial's non-insurance subsidiaries has guaranteed all
obligations of PAULA Financial under the Credit Agreement.

OPERATING SUBSIDIARIES

The sources of funds of the Company's operating subsidiaries are cash flows
from operating activities, investment income and capital contributions from
PAULA Financial. The insurance company operating subsidiaries' major uses of
funds are claim payments and underwriting and administrative expenses and
maintaining the required surplus to expand their insurance business. The agency
and TPA operating subsidiaries' major use of funds are operating expenses. The
nature of the workers' compensation insurance business is such that claim
payments are made over a longer period of time than the period over which
related premiums are collected. Operating cash flows and the portion of the
investment portfolio consisting of cash and liquid securities have historically
met the insurance company operating subsidiaries' liquidity requirements.
Operating cash flows and intercompany loans from PAULA Financial have
historically met the agency and TPA subsidiaries' liquidity requirements.

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 the two founders of PTC other than Pan Am as part of the
PICO investment portfolio. The Company's investments in fixed maturity
securities are carried at market value as such securities may be sold in
response to changes in interest rates, tax planning considerations or other
aspects of asset/liability management. As of June 30, 1997, the carrying value
of the Company's fixed maturity securities portfolio was $86.6 million and all
of the portfolio was rated "A" or better by S&P, Moody's or Fitch. See
"Business--Investments and Investment Results".

California workers' compensation insurance companies are required to
maintain some of their investments on deposit with the California DOI for the
protection of policyholders. Other states in which PICO is licensed have also
required PICO to post deposits for the protection of those states'
policyholders. Pursuant to applicable state laws, PICO had, as of June 30, 1997,
securities with a book value of $67.8 million held by authorized depositories
pursuant to these deposit requirements. In addition to the deposits, the
insurance company operating subsidiaries must maintain capital and surplus
levels related to premiums written and the risks retained by the subsidiaries.

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BUSINESS

THE COMPANY

For the six months ended June 30, 1997, the Company had $45.9 million of
premiums written, compared to $27.7 million for the comparable period in 1996,
an increase of 65.3%. For the year ended December 31, 1996, the Company had
premiums written of $63.6 million. The Company's primary geographic markets are
California, Arizona, and Oregon, which accounted for approximately 67.8%, 13.6%
and 12.0%, respectively, of premiums written for the six months ended June 30,
1997. Since 1995, the Company has commenced operations in Idaho, Texas, Florida
and Alaska and has been licensed in New Mexico.

The Company believes that its cumulative experience serving the agribusiness
industry has led to superior underwriting results and strong growth in
stockholders' equity per share. PICO's SAP combined ratio for the five years
ended December 31, 1996 averaged 99.6%, approximately 10.7 percentage points
below the California average for the workers' compensation insurance industry
(source: WCIRB) and 10.8 percentage points below the national average for the
workers' compensation insurance industry (source: A.M. Best; Best's Insurance
Reports, Property/Casualty, 1997 edition). Neither the WCIRB nor A.M. Best
publishes industry data on a GAAP basis. The Company's adjusted net
stockholders' equity per share has grown at a compound annual growth rate of
19.3% from January 1, 1981 to June 30, 1997 (21.5% over the 10 years ended June
30, 1997).

WORKERS' COMPENSATION SYSTEM

Workers' compensation is a statutory system under which an employer is
required to reimburse its employees for the costs of medical care and other
specified benefits for work-related injuries or illnesses. Most employers comply
with this requirement by purchasing workers' compensation insurance. The
principal concept underlying workers' compensation laws is that an employee
injured in the course of his employment has only the legal remedies for that
injury available under workers' compensation law and does not have any other
claims against his or her employer. Generally, workers are covered for injuries
which occur in the course and scope of their employment. The obligation to pay
such compensation does not depend on any negligence or wrong on the part of the
employer and exists even for injuries that result from the negligence or wrongs
of another person, including the employee.

Workers' compensation insurance policies obligate the carrier to pay all
benefits which the insured employer may become obligated to pay under applicable
workers' compensation laws. Each individual state has its own workers'
compensation regulatory system that determines the level of wage replacement to
be paid, the level of medical care required to be provided and the cost of
permanent impairment.

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For instance, there are four types of benefits payable under California workers'
compensation policies: (i) temporary or permanent disability benefits (either in
the form of short-term to life-term payments or lump sum payments); (ii)
vocational rehabilitation benefits; (iii) medical benefits; and (iv) death
benefits. The amount of benefits payable for various types of claims is
determined by regulation and varies with the severity and nature of the injury
or illness and the wage, occupation and age of the employee.

BUSINESS STRATEGY

The Company believes that its differentiated approach as a provider of
insurance services to the agribusiness industry and its expertise with immigrant
employee groups, partial year workforces and businesses in rural communities
have been critical to its success. The Company views its key strengths as: (i)
its integrated distribution and underwriting activities; (ii) the distinctive
labor relations and cost containment services it provides; and (iii) its
underwriting and risk management expertise with respect to agribusiness risks.
The Company intends to leverage these strengths to grow profitably while
continuing its specialty of focusing on small- and medium-sized agribusiness
employers. PICO's book of business, as measured by EAP, has grown from $49.3
million as of June 30, 1996 to $77.6 million as of June 30, 1997, an increase of
57.5%. The Company's growth has been achieved without the acquisition of other
insurance companies.

INTEGRATED DISTRIBUTION

The Company has developed an expertise in the agribusiness industry through
its long history of both distributing and underwriting insurance and through a
focus on the agent-customer relationship. PICO was formed by the owners of Pan
Am in 1974 to underwrite the workers' compensation portion of the business
distributed by Pan Am. The Company believes that Pan Am's direct interest in the
Company's success results in a cooperative relationship among the agent, the
underwriter, loss control consultants, claims management personnel and the
customer and its employees. Pan Am, which has 17 locations in California, Oregon
and Arizona, is the largest distributor for PICO, accounting for 46.4% of PICO's
premiums written for the six months ended June 30, 1997.

To enhance the Company's presence in rural areas not served by Pan Am, the
Company affiliates with insurance agencies of similar size and operating
histories to Pan Am. In late 1996 and early 1997, the Company made minority
equity investments aggregating $1.9 million in two regional commercial insurance
agencies, Parker, headquartered in Fresno, California, and CAPAX, headquartered
in Modesto, California. In 1996, the Company, Parker and CAPAX formed the PTC to
affiliate with other independent agencies. Typically, PTC member agencies have
extensive operating histories, a significant commercial insurance presence in
rural communities and historically high client persistency rates. As of June 30,
1997, ten agencies, including Parker and CAPAX, have affiliated with the PTC.
Pan Am and the other PTC agencies together distributed 70.8% of PICO's EAP as of
June 30, 1997. The Company

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believes that its close relationships with PTC member agencies assist it in
lowering its loss ratio, raising persistency rates and lowering acquisition
costs.

The Company believes it gains significant marketing benefits from the
endorsements Pan Am has developed for the Company. These endorsements by 22
prominent agribusiness trade associations have allowed the Company to be
identified with brand names significant to agribusiness customers. Trade
associations which have endorsed the Company have recommended the Company's
products and services to their members. Endorsements provide the Company with
access to large groups of potential customers without the usual sales process of
prospecting individual clients. The Company believes that solicitation of
association members results in a higher percentage of sales than do individual
unaffiliated solicitations.

LOWER LOSS RATIOS. The Company believes its ownership of Pan Am and its
coordinated operating activities with CAPAX and Parker provide the agencies with
a vested interest in the success of the Company and thereby result in the
submission of better risks by such agencies to PICO. Moreover, the Company
believes that these agencies better assist PICO in developing direct
relationships with their customers, aiding the Company's loss control efforts.

HIGHER PERSISTENCY RATES. For the five years ended December 31, 1996, the
Company retained an average of 89.4% of its customers annually, based on policy
count. In 1996, the Company retained 86.8% of its customers, based on policy
count. The Company believes this persistency rate is attributable in part to the
tailored services the Company provides to its agribusiness customers and its
integrated distribution strategy, which reduces the likelihood that agents will
move business to other insurers.

LOWER ACQUISITION COSTS. The Company believes that in order to compete for
business, many insurance companies have increased commission rates. Rather than
competing primarily based on commission rates, the Company attracts agencies to
the PTC by offering innovative products and distinctive services to agribusiness
employers. The commission the Company pays to Pan Am is eliminated when the
Company's operations are consolidated. The Company's adjusted acquisition costs
(defined as (i) commissions paid to third parties plus Pan Am's total expenses
less revenues from third parties divided by (ii) premiums earned) was 13.4% for
the six months ended June 30, 1997. Pan Am third party revenues are generated
primarily from the sale of group medical, general liability, life and disability
insurance products on behalf of unaffiliated insurance companies.

DISTINCTIVE SERVICES TO AGRIBUSINESS EMPLOYERS

LOSS PREVENTION. Since employee turnover is high among agribusiness
employers and labor intensive agribusiness requires little fixed equipment, the
Company's field representatives hold employee safety training, forklift training
and tail-gate sessions for the Company's clients and their employees. In
addition, the Company's field representatives train crew foremen and field
supervisors on safety practices, visit the workplace to help prevent fraudulent
claims and report safety concerns to the Company's loss control consultants and
underwriters. The Company's field representatives are a team of 16
community-based bilingual employees with agribusiness employment backgrounds.

CLAIMS REPORTING AND FRAUD DETECTION. The Company's Special Investigation
Unit reviews each claim for potential fraud as it is reported to the Company
rather than only those claims referred to the unit

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by claims adjusters after they suspect fraud, as the Company believes is more
typical in the industry. By reviewing every claim at an early stage, the Company
is able to take advantage of its experience in identifying the principal
indicators of fraud and thereby mitigate its exposure to fraudulent claims. The
Company has also implemented a toll-free injury reporting telephone number which
allows employers and injured workers to report claims more quickly.

CLAIMS MANAGEMENT EXPERTISE. The Company commits significant resources to
its claims operations. The Company's claims staff is bilingual, has an average
of 13 years of claims experience and typically manages 125 open claims per
examiner, which the Company believes is lower than the industry average.

BENEFIT DELIVERY AND EXPLANATION OF BENEFITS TO FARM WORKERS. It has been a
long-standing and distinctive practice of the Company's field representatives to
hand deliver first-time benefit checks and explain benefits in the language of
preference of the claimant. The Company believes this helps to reduce the cost
of claims, particularly by reducing the number of litigated claims. The
Company's field representatives also assist in returning employees to modified
duty as part of the Company's early return to work program.

RURAL MEDICAL CARE DELIVERY. The ability of an insurer to influence medical
costs is substantially different in rural areas than in metropolitan areas where
insurers can negotiate for meaningful discounts to physicians' fee schedules.
The Company believes that its longstanding relationships with rural medical
providers and its claims management approach, which emphasizes proper medical
protocol and utilization rather than significant fee discounting, allows it to
operate at a lower cost and return workers to the job more quickly.

MEDICAL DELIVERY IN MEXICO. The Company offers occupational medical
treatment options in Mexico in three approved clinics in Tijuana, Mexicali and
San Luis. The Company believes it is the only carrier to provide this service,
which allows covered employees to obtain culturally-compatible care in
sought-after private medical facilities in Mexico. The Company realizes
significant average cost savings from Mexico-based medical care compared with
comparable care in the United States.

AGRIBUSINESS UNDERWRITING EXPERTISE

The Company underwrites and prices its products with the objective of
earning an underwriting profit. The Company believes that its expertise and long
history serving agribusiness employers assist it in achieving this objective.
Though agribusiness is widely considered to be a "substandard" class of
insurance, the Company has consistently reported underwriting profitability
above both the California and national workers' compensation insurance industry
averages for all classes of business. For the five years ended December 31,
1996, PICO's SAP combined ratios have averaged 99.6% as compared to workers'
compensation insurance industry averages in California and nationally of 110.3%
and 110.4%, respectively, for the same time period (source: WCIRB and A.M. Best,
respectively). The Company's in-depth understanding of the risks in its target
market and its ability to price its product appropriately are the keys to these
results.

KNOWLEDGE OF AGRIBUSINESS RISKS. The Company's proprietary loss experience
database, its trade association endorsements and its understanding of the risk
management needs of agribusiness employers are the key elements of its
underwriting capabilities. The Company's rate making process benefits
significantly from more than 50 years of claim experience in the agribusiness
industry and a proprietary database built over 23 years. This database includes
experience by class of business and by subclass within those business classes in
which the Company specializes. The information in the database has been
developed over 20 years since PICO's inception and is relevant today in that the
Company continues to specialize in the same classes of business in which it has
historically focused. This experience has enabled the Company to differentiate
risks by creating more than 35 farm classes and subclasses, reflecting the
unique characteristics of job classifications and differences in farming

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operations. In comparison, the WCIRB publishes only 15 payroll classifications
in its schedule of farm rating reports.

TRADE ASSOCIATION ENDORSEMENTS AND SAFETY GROUPS. The Company enjoys the
endorsement of 22 agribusiness trade associations and has promoted the formation
and operation of 40 other safety groups that purchase workers' compensation
insurance from the Company. Each employer participating in these groups is
individually underwritten and then pooled with other homogeneous employers for
the purpose of rating experience. These groups help the Company to achieve the
actuarial benefit of writing larger pools, to provide safety training and
services to small accounts more efficiently and to promote the selection of good
risks and safety practices by linking the self interest of each group member.
The Company believes that the loss ratios of its trade association and safety
group customers have been lower than that of its customers as a whole. The trade
association endorsements, in particular, are also a good source of marketing and
provide penetration opportunities through access to association mailing lists.
As of June 30, 1997, approximately 64.2% of the Company's policies and 44.0% of
the Company's EAP were in trade associations and safety groups.

RISK MANAGEMENT. Risk management is the process of identifying and
analyzing loss exposures and taking steps to minimize the financial impact of
those exposures. The Company's loss control consultants, all of whom are
bilingual and are trained and certified in various farm safety practices, assist
the underwriters in reviewing new accounts and in initiating safety programs
based on industry best practices for each type of customer. The Company runs a
customized software system which networks the underwriters to field
representatives, loss control consultants, premium auditors, credit and
collections personnel and claims supervisors to provide renewal data and
schedule service visits. A record of all customer interaction is maintained for
review by the applicable underwriter, agent and customer.

GROWTH STRATEGY

EXPANSION INTO NEW STATES

The Company believes that it has significant growth opportunities outside of
its historic California and Arizona markets. In 1994, the Company began its
expansion by entering the Oregon market. Since then, it has entered five
additional states: Idaho, Texas, Florida, Alaska and New Mexico. Between January
1, 1995 and June 30, 1997, the Company added approximately 2,600 new customers,
as measured by policy count, outside of California and Arizona. In new states,
the Company targets the same types of small- to medium-sized agribusiness
operations that it has historically served. With the addition of New Mexico and
Texas, the Company is now licensed in all states that share a border with
Mexico. Migrant labor pools, however, stretch into Oregon, Idaho and any other
location where fresh food is hand harvested in the United States.

INCREASED PENETRATION WITHIN CALIFORNIA AND ARIZONA AGRIBUSINESS MARKETS

The Company believes that there are opportunities to grow within its
historic markets. The agribusiness economy in California is very large.
According to data compiled by the California Farm Bureau in 1996, California
farming enterprises, which are a portion of the Company's target market,
generated 9.5% of the state's total annual income and supported 1.4 million
jobs, or nearly 10% of the state total. The California Farm Bureau estimates
that California has over 80,000 farms, widely distributed in rural areas
throughout the state. The Company believes that these agribusiness employers
prefer to build

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long-term relationships with agents and to trade locally. Accordingly, the
Company has focused on building market share within well-defined rural
communities rather than broadly throughout the state. The Company has offices in
12 communities in California and has identified over 75 additional communities
in California that it believes represent significant growth opportunities for
the Company.

EXPANSION INTO RELATED INDUSTRIES

The Company has capitalized on its experience working in the agribusiness
industry by expanding into other industries with immigrant workforces,
including, grocery stores, restaurants and garment manufacturers. As of June 30,
1997, the Company insured 288 employers in the grocery industry, 789 employers
in the restaurant industry, and 511 employers in the garment industry. Like
agribusiness employers, these businesses typically hire low-wage immigrant labor
forces to perform semi-skilled labor and have risk characteristics and service
requirements similar to those of the Company's agribusiness client base. PTC
member agencies with expertise in these industries have been the key factor
behind the Company's growth in non-agribusiness industries. As of June 30, 1997,
the Company's non-agribusiness clients had EAP of $27.1 million, or 34.9% of the
Company's total EAP.

CUSTOMERS

AGRIBUSINESS

The Company has served the insurance needs of western agribusiness employers
and other employers of immigrant workers for over 50 years. The Company defines
"agribusiness" to include those employers who farm, harvest, transport, pack and
process tree fruit, vegetables, fiber, flowers, vine fruit, and dairy products.
Because the Company focuses on clients in a limited number of industries, it
believes it has developed expertise in assessing the risks associated with those
industries.

The agribusiness employer is typically a small, rural business with a
preference for building long-term relationships. These insurance buyers tend to
exhibit a high degree of loyalty to their insurance agent and typically transact
business locally. For the five years ended December 31, 1996, the Company
retained an average of 89.4% of its customers annually, based on policy count,
and an average of 83.0% of its EAP. Employers involved in the growing and
harvesting of fresh food are dependent on the productive employment of their
typically lower-wage, non-English speaking work force. Only with well-
supervised, high performing workers can agribusiness employers take advantage of
the short window of opportunity to sell their product for its highest price
during its "season". The Company's knowledge of these issues and its ability to
provide value-added benefits to these employers, such as bilingual supervisor
and foreman training and early return to work programs, have enabled the Company
to help its clients satisfy the benefits needs of their work forces and thereby
help to keep those laborers productive.

Labor intensive agribusiness insurance risks are generally characterized by:
(i) monolingual Spanish speaking workforces; (ii) moving work sites and a
relative lack of machinery and equipment, making loss control engineering more
difficult; (iii) large seasonal fluctuations and high turnover in the employee
pool, making timely and frequent safety training more critical and increasing
the opportunity for filing fraudulent claims; (iv) fewer opportunities for
discounts from health providers in rural locations; and (v) a relatively young
workforce performing physically demanding labor for low hourly or piece-work
wages. The Company's knowledge of these risk characteristics has enabled the
Company to help its clients satisfy the benefits needs of their workforces and
assisted it to achieve underwriting profitability.

The Company believes that the experience level required to be successful in
serving the agribusiness industry makes it difficult for competitors to enter
this market. In each state in which it operates, the Company's single largest
competitor for agribusiness is that state's workers' compensation insurance
fund. Due in part to the limited number of non-governmental carriers, state
funds have built substantial market share in the states where they exist.

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TRADE ASSOCIATIONS AND SAFETY GROUPS

Two significant factors in the Company's recent growth and profitability
have been the success of Pan Am in obtaining endorsements from agricultural
trade associations and in promoting the formation and operation of successful
safety groups. As of June 30, 1997, the Company had 62 such relationships,
including 22 trade association endorsements and 40 safety groups. As of June 30,
1997, EAP from the members of these organizations totaled $34.2 million, or
44.0% of the Company's total EAP (64.2% of total policies). The Company believes
that it gains significant marketing and underwriting benefits from these
relationships.

Trade association endorsements are made and renewed on an annual basis. As
of June 30, 1997, no single trade association accounted for more than 2% of the
Company's EAP. Trade associations offer the Company's products and services as a
benefit of membership. However, the Company individually underwrites each policy
and is not obligated to offer insurance to any trade association member. Trade
association endorsements give the Company visibility and recognition through
association with a brand name significant to its customers. They also allow the
Company actuarial benefits from the pooling of homogenous insurance risks and
access to large groups of potential customers without the usual sales process of
prospecting individual clients. The Company believes that once the Company has
obtained an association's endorsement, solicitation of association members
results in a higher percentage of sales than do individual unaffiliated
solicitations. In connection with the Company's recent entry into the Idaho
workers' compensation insurance marketplace, the Company's product was endorsed
by some of the principal agricultural associations in the state, including
potato, cattle, dairy, and grain associations. These endorsements were a
significant factor in the Company's early success in this market.

The Company works with significant independent employers or groups of
employers in selected crops or industries to form safety groups for group
insurance purchasing and safety training purposes. Safety groups are chartered
business entities which are registered with the applicable Department of
Insurance and formed primarily to encourage workplace safety among employer
members of the group and to purchase workers' compensation insurance as a group.
Generally, safety groups do not charge membership fees. Safety groups and trade
associations help the Company to achieve the actuarial benefit of writing larger
pools, to provide safety training and services to small accounts more
efficiently and to promote the selection of good risks and safety practices by
linking the self interest of each employer.

OTHER EMPLOYERS OF HISPANIC AND IMMIGRANT LABORERS

In recent years, the Company has leveraged its experience working with
non-English speaking immigrant workers into serving the needs of other
businesses employing low-wage, Hispanic workers and other immigrant populations.
Examples include Company programs focused on grocery stores, restaurants and
garment manufacturers. The Company has hired completely bi-cultural (of Hispanic
or Asian descent) loss control personnel and works closely with ethnic insurance
agency forces in these programs.

DISTRIBUTION

DIRECT

The Company, operating through its wholly-owned subsidiary Pan Am,
distributes its workers' compensation products to employers in California,
Arizona and Oregon. Management believes Pan Am is one of the largest agency
operations specializing in offering employee benefit products to
agribusiness-related employers in California and Arizona. Pan Am primarily has
grown internally, to a current full-time sales force of approximately 40, with
commission revenues (before intercompany eliminations) of $10.0 million in 1996
and $4.5 million in the six months ended June 30, 1997. Pan Am, as agent and
broker, offers its customers a wide range of insurance products tailored to
agribusiness employers' specific needs.

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Pan Am's revenues are derived from commissions from the placement of
insurance with insurance carriers, including PICO and PACO. In 1996, Pan Am
placed 48.3% of its total insurance premiums with PICO and PACO. The Company's
integration of the sales and underwriting elements of the workers' compensation
insurance business sold through Pan Am enhances the Company's ability to retain
this business. PICO's insurance business sold through Pan Am is not subject to
being moved at the sole discretion of the agent, although PICO's insurance sold
through Pan Am is still subject to competition from other insurance carriers.
For the six months ended June 30, 1997, approximately 46.4% of PICO's premiums
written was sold through Pan Am.

Pan Am has approximately 70 full-time equivalent employees operating from 17
offices in California, Arizona and Oregon. Many of these locations also house
PICO personnel and operations. This provides Pan Am sales personnel with direct
access to insurance company underwriting and claims personnel which, the Company
believes, improves the effectiveness of Pan Am's sales and servicing efforts.

PAULA TRADING COMPANY

To enhance the Company's presence in rural areas not served by Pan Am, the
Company affiliates with insurance agencies of similar size and operating
histories to Pan Am. In late 1996 and early 1997, the Company made minority
equity investments aggregating $1.9 million in Parker and CAPAX, two regional
commercial insurance agencies. In 1996, the Company, Parker and CAPAX formed the
PTC to affiliate with other independent agencies. Typically, PTC member agencies
have extensive operating histories, a significant commercial insurance presence
in rural communities and historically high client persistency rates. As of June
30, 1997, ten agencies, including Parker and CAPAX, have affiliated with the
PTC. Pan Am and the other PTC agencies together distributed 70.8% of PICO's EAP
as of June 30, 1997. The Company believes that its close relationships with PTC
member agencies assist it in lowering its loss ratio, raising persistency rates
and lowering acquisition costs.

The insurance agencies that have been selected to join the PTC are expected
to submit applications on risks where there is a high likelihood of PICO
successfully writing the business. PICO also typically expects the first and
last chance to quote agribusiness or Hispanic-focused workers' compensation
business written by a PTC member. The agencies also pay an annual fee to the
PTC. PTC members have access to PAULA's innovative product features such as the
employment practices liability insurance products described below and have the
potential to join an insurance agency marketing arrangement established by the
founders of the PTC. The Company believes the PTC allows the Company to receive
better quality insurance submissions, face less price competition and maintain
relatively low insurance business acquisition costs.

INDEPENDENT INSURANCE AGENTS

The Company has appointed a limited number of independent insurance agents
to sell its workers' compensation insurance, primarily in jurisdictions not well
covered by PTC members. The Company favors appointing independent agents who
will primarily represent the Company in its desired agribusiness focused markets
rather than presenting the Company as one of many competing quotes together in a
pricing comparison. As of June 30, 1997, independent insurance agencies,
exclusive of the PTC agencies, accounted for 29.2% of PICO's EAP.

OTHER AGENCY OPERATIONS

Other products and services offered by Pan Am include group health
insurance, third party administration, managed care programs, property and
casualty insurance, crop insurance, life and disability insurance and other
financial services.

37
<PAGE>
SCOPE OF OPERATIONS

The Company has operated successfully in California for more than 50 years
and Arizona for more than 40 years. In 1994, the Company commenced operations in
Oregon to test whether its business formula would prove successful in other
jurisdictions. The Company wrote its first policy in Oregon on January 1, 1995.
For the years ended December 31, 1995 and 1996 and for the six months ended June
30, 1997, the Company recorded premiums written in Oregon of $4.6 million, $9.5
million, and $5.5 million, respectively. The Company next commenced operations
in Idaho, where it wrote its first policy on July 1, 1996, just prior to the
legislative requirement that workers' compensation insurance become mandatory
for agricultural employers for the first time in January 1997. For the year
ended December 31, 1996 and the six months ended June 30, 1997, the Company
recorded premiums written in Idaho of $0.7 million and $2.2 million,
respectively. As of June 30, 1997, the Company had approximately 1,750 policies
in Oregon and approximately 730 policies in Idaho. Most recently, based on the
success of the Company's Oregon and Idaho expansion, the Company has expanded
into Texas, Florida, Alaska and New Mexico.

The Company believes that a positive reception in new states depends, in
large part, on its ability to: (i) communicate its agribusiness expertise; (ii)
establish strong relationships with local agents; (iii) leverage its current
endorsements and attract new endorsements from agribusiness associations; and
(iv) deliver a high level of service to employers. The Company has focused its
expansion in states with significant labor-intensive agribusiness insurance
opportunities. The Company anticipates that it will continue to expand into
additional states with significant labor-intensive agribusiness payrolls in
future years, although no particular expansion is planned. The Company plans to
grow its business within each of these new states by identifying and marketing
its products to agribusiness employers in rural areas.

The Company wrote its first policy in Texas in early 1997. The Company was
admitted to write workers' compensation insurance in New Mexico and Florida in
early 1997, wrote its first policy in Florida in July 1997 and has not yet
commenced writing insurance in New Mexico. The Company commenced writing
policies in Alaska in 1996. The Company believes it is the only carrier
primarily focused on the workers' compensation insurance needs of agribusiness
employers in Arizona, Oregon, Idaho and Texas.

The following table sets forth the geographic distribution of premiums
written:

<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1996 JUNE 30, 1997
------------------------ ------------------------
% OF TOTAL % OF TOTAL
PREMIUMS PREMIUMS PREMIUMS PREMIUMS
STATE WRITTEN WRITTEN WRITTEN WRITTEN
- ---------------------------------------------------------------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
California...................................................... $ 40,811 64.2% $ 31,086 67.8%
Arizona......................................................... 12,473 19.6 6,256 13.6
Oregon.......................................................... 9,472 14.9 5,500 12.0
Idaho........................................................... 685 1.1 2,199 4.8
Alaska.......................................................... 165 0.2 660 1.4
Texas........................................................... -- -- 170 0.4
----------- ----- ----------- -----
Total......................................................... $ 63,606 100.0% $ 45,871 100.0%
----------- ----- ----------- -----
----------- ----- ----------- -----
</TABLE>

PRODUCTS AND SERVICES

The Company's principal product consists of workers' compensation insurance
policies sold primarily to agribusiness employers. For the year ended December
31, 1996 and the six months ended

38
<PAGE>
June 30, 1997, workers' compensation premiums earned accounted for 83.0% and
89.1%, respectively, of the Company's revenues.

In order to differentiate its product from its competitors and provide the
members of the PTC with points of difference to aid them with the sale and
retention of business, the Company has developed a number of innovative product
features, including: (i) automatic coverage in California for discrimination
claims based on an employee's intent to file a workers' compensation claim; (ii)
employment practices liability insurance in California ("EPL"), which provides
coverage for sexual harassment, wrongful termination and discrimination; (iii)
automatic benefits for the provision of occupational medicine to workers'
compensation claimants in Mexico; and (iv) additional premium credit to the
insured employer in California when the agent provides both the workers'
compensation and health insurance to the employer client and its employees. The
Company has entered into a quota-share reinsurance agreement with the Venton
Syndicate of Lloyd's of London with respect to the underwriting risk of its EPL
product. The Company's EPL product was introduced in April 1997 and generated
only nominal premiums written for the six months ended June 30, 1997.

The Company sells "AmeriMex", a product underwritten by PACO, which is
typically sold alongside PICO's workers' compensation product in California, and
which provides group medical benefits for services rendered at three provider
hospitals in Mexico. PACO also offers low limit group term life and accidental
death and dismemberment insurance to employer groups. The Company's TPA services
consist of the independent administration of claims and related matters for
self-insured employers' health benefit plans. For the six months ended June 30,
1997, TPA, group medical and group life products accounted for an aggregate of
less than 2% of the Company's revenues. These products are typically sold to the
same employers that purchase the Company's workers' compensation products.

As a general commercial agent, Pan Am distributes group health insurance,
property and casualty insurance, life and disability insurance and other
products underwritten by unaffiliated insurance companies to the Company's
agribusiness clients. The Company believes that the ability of Pan Am to offer
these products and the ability of Pan Am and the PTC member agencies to offer
the Company's distinctive products strengthen the relationship between the agent
and the Company's policyholders.

UNDERWRITING

RISK SELECTION

The Company's proprietary loss experience database, its trade association
endorsements and its understanding of the risk management needs of agribusiness
employers are the key elements of its underwriting and marketing capabilities.
The Company's rate making process benefits significantly from more than 50 years
of claim experience in the agribusiness industry and a proprietary database
built over 23 years. This experience has enabled the Company to differentiate
risks by creating more than 35 farm classes and subclasses, reflecting the
unique characteristics of job classifications and differences in farming
operations. In comparison, the WCIRB publishes only 15 payroll classifications
in its schedule of farm rating reports.

The Company's focus allows it to concentrate on agribusiness in rural areas
where litigation, fraud and abuse, which tend to increase the frequency of
claims as well as the Company's LAE, are less pronounced. The Company believes
the historically lower claim frequency and LAE in these areas are due in large
part to the stronger work ethic and lower wage level in these areas coupled with
a lower density of attorneys and medical-legal injury evaluation clinics.

Substantially all of PICO's business is produced through Pan Am and a group
of selected independent agents which have a local presence in the major
agricultural areas throughout the Company's operating markets. The Company
believes that this local involvement in rural communities allows its agents to
gain insight into the insureds' financial stability, ability to run their
business, attitudes toward

39
<PAGE>
safety and loss control and willingness to work as partners with the Company in
the management of their workers' compensation program.

The Company focuses on small- to medium-sized accounts which make up the
broadest segment of agribusiness employers. PICO's average annual workers'
compensation policy premium, as measured by EAP, was approximately $9,500 as of
December 31, 1996. The Company has found that smaller businesses tend to be
supervised by the owner rather than management staff. The Company believes that
an employer's claims experience directly depends on the owner's commitment to
workplace safety and its hiring practices. By underwriting small- to
medium-sized accounts, the Company has an opportunity to assess directly the
owners' commitment to workplace safety rather than trying to assess such
commitment through interaction with management staff.

UNDERWRITING PROCESS

PICO's relationship with Pan Am and other agents allows the pre-screening by
such agents of new workers' compensation accounts according to criteria
established by PICO, including the employers' prior loss experience, hiring
practices, safety record, credit history, geographic location and types of job
assignments within employment classifications. The Company's agents also meet
with the employer's management to assess the extent to which management is
committed to safety in the workplace. The Company believes that this initial
screening of potential clients improves risk selection.

Once an account passes this initial screening process and prior to approving
an application, the Company's underwriting department reviews each employer
applicant's prior loss experience, safety record, operations, geographic
location and payroll classifications and the types of job assignments within
employment classifications. If necessary, and in most cases for accounts with
EAP of $250,000 or greater, a pre-inspection is conducted by the Company's loss
control department to evaluate safety in the workplace, hiring practices,
industrial health hazards and the potential insured's enthusiasm for loss
control and workplace safety. The Company's underwriters evaluate the potential
profitability of each insurance application by analyzing the various potential
loss exposures related to that particular risk compared to the standard
exposures in that classification. The Company's concentration in the
agribusiness industry permits this comparison to be done in a more thorough and
cost effective manner.

The Company runs a customized software system which networks the
underwriters to field representatives, loss control consultants, premium
auditors, credit and collections personnel and claims supervisors to provide
renewal data and schedule service visits. A record of all customer interaction
is maintained for the underwriters' review. On larger risks, the Company's
underwriters consult with the Company's senior claims management personnel
during the underwriting process. For new business submissions, this process
improves the Company's ability to estimate an employer's expected claims
experience. For renewing businesses, this process informs the underwriters of
the Company's experience handling claims for the particular employer and the
employer's attitude toward safety, cooperation in the claims settlement process,
return to work efforts and collection payment history. Any expected change in
reserves is also discussed in the renewal business claims review.

Once an account is written, a service plan is put into place utilizing a
team of bilingual field representatives, certified loss control specialists and
employer personnel to establish and periodically review formal and informal
safety programs, safety committees, conformity with OSHA standards, procedures
for reporting injuries, medical cost containment, anti-fraud information,
accident investigation, safety incentive/rewards programs and claims review
procedures. A service call by claims and field personnel is scheduled with each
account with EAP in excess of $25,000. The Company's field representatives
provide a number of valuable services for the Company's underwriting and claims
personnel as well as to the Company's insured employers. All of the field
representatives speak English and Spanish. The field representatives spend their
working hours making periodic visits to the Company's insured employers and
their workers. Among other things, the field representatives provide feedback to

40
<PAGE>
the Company's underwriting personnel about particular accounts and their
attitude toward, and actions to implement, workplace safety. Input from the
field representatives influences rating and pricing decisions by the Company's
underwriters. The Company uses its bilingual, state-certified loss control
personnel to hold safety seminars to train insureds' employees.

The Company has established an underwriting referral policy designed to
allow the Company's senior underwriting officer to review all large and unusual
underwriting opportunities. All accounts with (i) high EAP, (ii) high experience
modifications (indicating poor prior claims experience), (iii) a projected
overall rate reduction at renewal, or (iv) large variations from the Company's
standard rates are reviewed by the senior underwriting officer, together with
the senior claims officer, senior loss control officer and chief operating
officer.

UNDERWRITING PERSONNEL

The Company's underwriting department consists of nine senior underwriters
with an average of 22 years experience in property/casualty underwriting and
eight other underwriting staff members. Each of the senior underwriters is given
individually determined binding authority. All of the Company's underwriters are
expected to spend a significant portion of their time out of the office visiting
agents and policyholders.

PRICING

The amount of premium the Company charges for workers' compensation
insurance is dependent on the size of an employer's payroll, the job
classifications of its employees and the application of the Company's rating
plan to each individual employer. The Company's rating plan varies from state to
state due to differences in regulatory environments. In certain states, the
premium rate charged to a particular employer may be affected by a risk premium
modifier if the employer is a member of a safety group or meets certain safety
or other requirements. Each employer's indicated premium is then adjusted based
on the employer's experience modification, which is determined by a third party
rating bureau. Application of the experience modification factor results in an
increase or decrease to the indicated premium rate based on the employer's loss
experience and, therefore, provides an incentive to employers to reduce
work-related injuries and illnesses.

In certain states, at the time the Company issues a policy to an employer,
the Company is paid a deposit premium, which is a percentage of the EAP of the
policy at the time of issuance. The percentage ranges from 10% to 100% of the
EAP depending, among other things, on the premium payment schedule, the
employer's credit history and employment classifications. The employer remits
its premiums either in installments based on a payment plan or in amounts
calculated from periodic reports of its payrolls. At the end of the policy term,
or when the policy is cancelled, a final audit of the employer's records is
conducted by the Company to determine the correct amount of premium due to the
Company.

For a description of regulation of workers' compensation insurance premium
rates, see
"Business--Regulation--Regulation of PICO's Business in Each State in Which it
is Licensed".

CLAIMS

The Company's policy is to protect injured workers or their dependents and
policyholders by promptly investigating each loss occurrence, administering
benefits in a prompt, efficient and cost effective manner and maintaining an
appropriate reserve estimate on each claim through closure. The Company expends
significant efforts to improve its insureds' claim experience. Because the
Company charges insurance rates based in part on an insured's claims experience
over a three-year period, improvements in an insured's claims experience are not
immediately reflected in lower rates, thereby

41
<PAGE>
providing an opportunity for the Company's loss ratio to improve as each
accounts' claims experience is reduced.

MANAGEMENT OF CLAIMS COSTS

The Company's Special Investigation Unit reviews each claim for potential
fraud as it is reported to the Company rather than only those claims referred to
the unit by claims adjusters after they suspect fraud, as the Company believes
is more typical in the industry. By reviewing every claim at an early stage, the
Company is able to take advantage of its experience in identifying the principal
indicators of fraud and thereby mitigate its exposure to fraudulent claims. The
Company believes its Special Investigation Unit's review of every claim
diminishes the number of fraudulent claims paid by the Company and is
responsible in part for lowering the Company's loss ratio. The Company has also
established a separate litigation management unit, utilizing its own
administrative hearing representatives, which makes extensive use of alternative
dispute resolution techniques to settle claims prior to these claims going
before local workers' compensation appeals boards. The Company holds special
one-day arbitration conferences with retired workers' compensation judges at
least quarterly and attempts to settle pending claims at these conferences.

In addition, the Company has taken significant steps to reduce its outside
legal fee expenses when litigated claims cannot be resolved by the Company's
in-house litigation personnel. The Company has entered into capitation
arrangements with each of the members of its panel of outside law firms. These
arrangements limit the amount the Company will be charged by its attorneys for
given legal actions. The Company believes these capitation arrangements have
reduced its LAE.

As an integral part of its claims operations, PICO utilizes specially
trained personnel, both employees and independent contractors, to carry out cost
containment techniques in the areas of medical management, litigation
management, vocational rehabilitation management, subrogation management, fraud
investigation, bill review, utilization review and benefit delivery compliance.
The Company's medical management efforts are devoted to providing medical
utilization review and quality assurance with the objectives of controlling unit
cost, volume of services and lost work days due to work-related injury and
illness. In particular, due to its long experience in rural markets, the Company
understands how the delivery of occupational medical services varies in rural
areas from metropolitan areas, allowing the Company, it believes, to more
effectively utilize its rights to direct injured workers to medical providers
approved by the Company during the first weeks after an injury occurs.

Claims management is further enhanced by the Company's bilingual field
representatives who assist in the benefit-delivery process and the explanation
of benefits to injured workers in their language of preference. A substantial
majority of the Company's loss control and field representatives have prior work
experience in the businesses in which the Company's clients operate. The Company
believes that it can mitigate claim incidence and duration and prevent the
settlement of claims from becoming an adversarial process by maintaining open
communication with the farm worker communities. To that end, the Company's field
representatives personally deliver the first claims payment to each injured
worker, which the Company believes leads to greater cooperation in the ultimate
settlement of claims and fulfills a fraud prevention function by allowing
Company personnel to meet and evaluate the injured worker. In addition, the
Company's claims department has operated for many years with a bilingual and
cross-cultural claims examination workforce, which facilitates more rapid
explanation of benefits and settlement of claims with Spanish speaking
claimants.

The Company has implemented a toll-free injury reporting telephone number
which allows employers and injured workers to report claims more quickly.
Callers receive assistance reporting their claim and the Company's claims
personnel receive a "head start" on the management of the costs of that claim.
The head start allows the Company to investigate the circumstances of the injury
to determine the claim status, assist the injured worker in the selection of
medical providers approved by the Company

42
<PAGE>
and assist the injured party through the claims process in a manner designed to
reduce the likelihood that the injured party will need to seek the assistance of
legal counsel with the claims process. The Company believes that there is a
direct relationship between the speed with which it learns of a claim and its
ability to reduce the cost of the claim to its lowest possible value.

The Company has created a panel of medical providers practicing in three
facilities in Mexico who are skilled in delivering occupational medicine in a
manner consistent with the requirements of the California workers' compensation
system at less cost than United States providers for those workers more
comfortable with Mexico clinics and hospitals. For instance, a common inguinal
hernia repair which may cost over $4,000 in the United States costs as little as
$1,600 in one of these medical-provider facilities.

CLAIMS PERSONNEL

The Company's claims management is conducted under the direction of 14
claims management personnel with an average of 18 years of experience in the
industry. The Company's claims examiners are responsible for the management of
caseloads typically averaging below 125 claims per examiner, which the Company
believes is lower than the industry average. Due to the combination of
experience and manageable caseloads, the Company's claims personnel can be
effective at managing claims through frequent contact with policyholders,
injured workers and medical providers. Moreover, the Company's claims personnel
are able to quickly and cost effectively respond to changes in mandated workers'
compensation benefits. The Company maintains claims processing offices with
Spanish-speaking bilingual staff in seven of its 21 offices.

LOSSES AND LOSS RESERVES

In many cases, significant periods of time may elapse between the occurrence
of an insured loss, the reporting of the loss to the insurer and the insurer's
payment of that loss. To recognize liabilities for unpaid losses, insurers
establish reserves, which are balance sheet liabilities representing estimates
of future amounts needed to pay claims with respect to insured events that have
occurred, including events that have occurred but have not yet been reported to
the insurer. Reserves are also established for LAE representing the estimated
expenses of settling claims, including legal and other fees, and general
expenses of administering the claims adjustment process.

Reserves for losses and LAE are based not only on historical experience but
also on management's judgment of the effects of factors such as future economic
and social forces likely to impact the insurer's experience relative to the type
of risk involved, benefit changes, circumstances surrounding individual claims
and trends that may affect the probable number and nature of claims arising from
losses not yet reported. Consequently, loss reserves are inherently subject to a
number of highly variable circumstances.

Reserves for losses and LAE are evaluated quarterly using a variety of
actuarial and statistical techniques for producing current estimates of expected
claim costs. Claim frequency and severity and other economic and social factors
are considered in the evaluation process. Since the Company relies on both
actual historical data, which reflect past inflation, and on other factors which
are judged to be appropriate modifiers of past experience, the Company uses an
implied, rather than explicit, provision for inflation in its calculation of
estimated future claim costs. Adjustments to reserves are reflected in operating
results for the periods in which they are made.

The Company sets an initial case reserve upon being notified of an insured
injury. Since 1992, the Company has employed automated computer technology
utilizing a database comprised of data from participating unaffiliated workers'
compensation carriers to assist the Company in setting such initial reserves. As
more facts regarding the loss become known, the Company reviews and, if
appropriate, revises the initial case loss reserve.

In addition to case reserves, the Company also establishes bulk reserves.
Bulk reserves are established on an aggregate basis to provide for losses
incurred but not yet reported to the insurer and

43
<PAGE>
to supplement the overall adequacy of individual case reserves established by
claims adjusters and estimated expenses of settling such claims, including legal
and other fees and general expenses of administering the claims adjustment
process. The Company establishes bulk reserves by estimating the ultimate net
liability for losses and LAE by using actuarial reserving techniques. Such
techniques are used to adjust, in the aggregate, the amount estimated for
individually established case reserves, as well as to establish estimates for
reserves for unreported claims. Adjustments are made for changes in the volume
and mix of business, mix of claim categories, claims processing and other items
which affect the development patterns over time.

On the basis of the Company's internal procedures which analyze, among other
things, the Company's experience with similar cases and historical trends such
as reserving patterns, loss payments and pending levels of unpaid claims, as
well as court decisions, economic conditions and public attitudes, management
has made its best estimate of the Company's liabilities for unpaid losses and
LAE and believes that adequate provision has been made for such items. However,
because the establishment of loss reserves is an inherently uncertain process,
there can be no assurance that ultimate losses and LAE will not exceed the
Company's reserves. There can be no assurance that future loss development will
not require reserves for prior periods to be increased, which would adversely
affect earnings in future periods.

The following table sets forth a reconciliation of beginning and ending
reserves for losses and LAE after reinsurance deductions for the periods
indicated. There are no material differences between the Company's reserves for
losses and LAE shown below calculated in accordance with GAAP and those
calculated in accordance with SAP. The Company does not discount claim reserves
on either a GAAP basis or under SAP.

RECONCILIATION OF RESERVES FOR LOSSES AND LAE

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
------------------------------- ENDED JUNE 30,
1994 1995 1996 1997
--------- --------- --------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Unpaid loss and loss adjustment expenses beginning of
period..................................................... $ 62,629 $ 60,473 $ 57,049 $ 55,720
Less: reinsurance recoverable on unpaid losses and LAE....... 5,402 6,886 6,775 6,427
PACO reserves............................................ 435 300 292 533
--------- --------- --------- ---------------
Net PICO balance, beginning of period...................... $ 56,792 $ 53,287 $ 49,982 $ 48,760

Incurred related to:
Current period............................................. 32,469 33,048 35,938 28,937
Prior periods.............................................. (3,955) (3,884) (2,646) (800)
--------- --------- --------- ---------------
$ 28,514 $ 29,164 $ 33,292 $ 28,137

Paid related to:
Current period............................................. 10,307 10,727 12,833 4,948
Prior periods.............................................. 21,712 21,742 21,681 13,997
--------- --------- --------- ---------------
$ 32,019 $ 32,469 $ 34,514 $ 18,945

Net PICO balance, end of period............................ 53,287 49,982 48,760 57,952
Plus: reinsurance recoverable on unpaid losses and LAE....... 6,886 6,775 6,427 6,437
PACO reserves............................................ 300 292 533 583
--------- --------- --------- ---------------

Unpaid loss and loss adjustment expenses, end of period...... $ 60,473 $ 57,049 $ 55,720 $ 64,972
--------- --------- --------- ---------------
--------- --------- --------- ---------------
</TABLE>

44
<PAGE>
The table below shows changes in historical workers' compensation net loss
and LAE reserves for PICO for each year since 1986. Reported reserve development
is derived from information included in PICO's statutory financial statements.
The first line of the upper portion of the table shows the net reserves as of
December 31 of each of the indicated years, representing the estimated amounts
of net outstanding losses and LAE for claims arising during that year and in all
prior years that are unpaid, including losses that have been incurred but not
yet reported to the Company. The upper portion of the table shows the
reestimated amount of the previously recorded net reserves for each year based
on experience as of the end of each succeeding year. The estimate changes as
more information becomes known about claims for individual years. The lower
portion of the table shows the cumulative net amounts paid as of December 31 of
successive years with respect to the net reserve liability for each year.

In evaluating the information in the table below, it should be noted that
each amount includes the effects of all changes in amounts for prior periods.
For example, if a loss determined in 1990 to be $10,000 was first reserved in
1987 at $8,000, the $2,000 deficiency would be included in the cumulative
redundancy (deficiency) for each of the years 1987 through 1990 shown below.
This table, unlike the table headed "Calendar Year Development by Accident Year"
that follows, does not present accident or policy year development data.
Conditions and trends that have affected the development of liability in the
past may not necessarily occur in the future. Accordingly, it may not be
appropriate to extrapolate future redundancies or deficiencies based on this
table.

45
<PAGE>
CHANGES IN HISTORICAL NET RESERVES FOR LOSSES AND LAE
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1986 1987 1988 1989 1990 1991 1992 1993 1994
--------- --------- --------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
Unpaid losses and loss
adjustment expenses at
end of year.............. $ 43,620 $ 49,221 $ 52,893 $ 49,994 $ 49,104 $ 57,909 $ 59,492 $ 56,792 $ 53,287

Reserve reestimated as
of:
One year later......... 43,278 46,450 47,061 47,833 52,209 58,618 57,000 52,837 49,403
Two years later........ 41,175 44,777 46,462 50,060 53,491 60,095 57,115 50,480 48,189
Three years later...... 40,020 44,294 47,725 49,970 54,316 60,733 55,305 50,647
Four years later....... 39,564 44,507 47,473 50,321 55,269 59,806 56,725
Five years later....... 39,619 44,336 47,064 51,095 54,808 60,286
Six years later........ 39,192 43,948 47,444 51,025 55,184
Seven years later...... 38,889 44,092 47,346 51,348
Eight years later...... 39,111 44,077 47,847
Nine years later....... 39,074 44,468
Ten years later........ 39,434

Cumulative redundancy
(deficiency)............. 4,186 4,753 5,046 (1,354) (6,080) (2,377) 2,767 6,145 5,098
Cumulative paid as of:
One year later......... 12,587 14,289 16,761 19,757 21,736 25,543 23,464 21,711 21,742
Two years later........ 21,466 25,290 29,212 32,602 36,021 40,328 37,040 34,721 33,601
Three years later...... 27,965 33,298 36,832 40,456 43,482 48,429 45,529 41,855
Four years later....... 32,536 37,758 41,251 44,254 47,923 53,416 50,395
Five years later....... 35,124 40,320 43,271 46,682 50,713 56,250
Six years later........ 36,632 41,295 44,676 48,430 52,442
Seven years later...... 37,046 42,083 45,562 49,406
Eight years later...... 37,675 42,723 46,465
Nine years later....... 38,105 43,388
Ten years later........ 38,641

Net unpaid losses and
loss adjustment
expenses--December 31.... $ 56,792 $ 53,287
Reinsurance Recoverable.. 5,402 6,886
--------- ---------
Gross unpaid losses and
loss adjustment
expenses--December 31.... $ 62,194 $ 60,173
--------- ---------
--------- ---------
Re-estimated net unpaid
losses and loss
adjustment expenses...... $ 50,647 $ 48,189
Re-estimated reinsurance
recoverable.............. 6,497 5,947
--------- ---------
Re-estimated gross unpaid
losses and loss
adjustment expenses...... $ 57,144 $ 54,136
--------- ---------
--------- ---------
Gross cumulative
redundancy
(deficiency)............. $ 5,050 $ 6,037
--------- ---------
--------- ---------

<S> <C> <C>
1995 1996
--------- ---------

Unpaid losses and loss
adjustment expenses at
end of year.............. $ 49,982 $ 48,760
Reserve reestimated as
of:
One year later......... 47,335
Two years later........
Three years later......
Four years later.......
Five years later.......
Six years later........
Seven years later......
Eight years later......
Nine years later.......
Ten years later........
Cumulative redundancy
(deficiency)............. 2,647
Cumulative paid as of:
One year later......... 21,680
Two years later........
Three years later......
Four years later.......
Five years later.......
Six years later........
Seven years later......
Eight years later......
Nine years later.......
Ten years later........
Net unpaid losses and
loss adjustment
expenses--December 31.... $ 49,982 $ 48,760
Reinsurance Recoverable.. 6,775 6,427
--------- ---------
Gross unpaid losses and
loss adjustment
expenses--December 31.... $ 56,757 $ 55,187
--------- ---------
--------- ---------
Re-estimated net unpaid
losses and loss
adjustment expenses...... $ 47,335
Re-estimated reinsurance
recoverable.............. 5,786
---------
Re-estimated gross unpaid
losses and loss
adjustment expenses...... $ 53,121
---------
---------
Gross cumulative
redundancy
(deficiency)............. $ 3,636
---------
---------
</TABLE>

46
<PAGE>
The following table is derived from the table above and summarizes the
effect of reserve reestimates net of ceded reinsurance on calendar year
operations for the same ten-year period ended December 31, 1996. The total of
each row details the amount of reserve reestimates made in the indicated
calendar year and shows the accident years to which the reestimates are
applicable. The total of each accident year column represents the cumulative
reserve reestimates for the indicated accident year(s).

CALENDAR YEAR DEVELOPMENT BY ACCIDENT YEAR
<TABLE>
<CAPTION>
ACCIDENT YEAR
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1986
AND
PRIOR 1987 1988 1989 1990 1991 1992 1993 1994 1995
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
(INCREASE) DECREASE IN RESERVES (IN THOUSANDS)
Calendar
Years ---------
1996.................. $ (360) $ (31) $ (110) $ 178 $ (53) $ (104) $ (940) $ 1,253 $ 1,381 $ 1,433
1995.................. 37 (22) 83 (28) 391 466 883 547 1,527
1994.................. (222) 78 (236) (394) (179) 315 523 4,070
1993.................. 303 85 21 (760) (474) (652) 3,969
1992.................. 427 (256) 81 (162) (1,372) 573
1991.................. (55) (158) (1,050) (964) (878)
1990.................. 456 27 116 1,562
1989.................. 1,155 518 4,159
1988.................. 2,103 668
1987.................. 342
Cumulative Reestimates
For Each Accident
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
Year................ $ 4,186 $ 909 $ 3,064 $ (568) $ (2,565) $ 598 $ 4,435 $ 5,870 $ 2,908 $ 1,433
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------

<S> <C>
TOTAL
CALENDAR
YEAR EFFECT
-----------

Calendar
Years ---------
1996.................. $ 2,647
1995.................. 3,884
1994.................. 3,955
1993.................. 2,492
1992.................. (709)
1991.................. (3,105)
1990.................. 2,161
1989.................. 5,832
1988.................. 2,771
1987.................. 342
Cumulative Reestimates
For Each Accident
-----------
Year................ $ 20,270
-----------
-----------
</TABLE>

As illustrated by this table, there have been no significant adverse
developments in PICO's reserve for any accident year from 1986 through 1995
except for 1990 which is discussed below. While PICO has historically applied,
and continues to apply, a consistent methodology in establishing its reserves,
there can be no assurance that significant adverse developments in PICO's
reserves will not occur in the future.

PICO and the California workers' compensation industry as a whole
experienced relatively high incurred losses and LAE during accident years 1989 -
1992 as a result of laws enacted in 1989 which had the unintended effect of
permitting the filing of fraudulent and abusive workers' compensation claims.
Those laws included, among others, a law allowing an injured employee to visit a
physician without giving the employer prior notice of a claim and a law
shortening the time during which a carrier had to approve or deny a claim, which
hindered carriers' ability to investigate claims suspected of involving fraud.
PICO determined reserves for accident years 1993 and 1994, and to a lesser
extent, 1995 and 1996, based on the relatively high incurred loss and LAE trends
for the 1989 - 1992 accident years. PICO's actual incurred losses and LAE for
the 1993 - 1995 accident years proved to be lower than anticipated and PICO's
original reserves for these periods were ultimately redundant. PICO's favorable
development of reserves for the 1993 and 1994 accident years and, to a lesser
extent, for the 1995 accident year is attributable to the implementation of
significant workers' compensation reform in California in 1993 and aggressive
fraud enforcement by PICO, the industry and California authorities beginning
around the same time.

PICO determined its reserves for the 1994 - 1996 accident years with the
benefit of information indicating favorable development in the immediate prior
accident years. Development of the 1994 and 1995 accident years has more closely
approximated the development anticipated when reserves for those years were
initially established.

47
<PAGE>
In 1996, PICO experienced an aggregate of approximately $2.6 million in
reserve recoveries attributable primarily to favorable development on losses and
LAE for the 1993 - 1995 accident years, offset in part by mildly negative
development for the 1990 - 1992 accident years. PICO attributes this favorable
development in part to favorable industry trends as well as to PICO's continued
improvement in claims management and management of the medical and legal
components of its workers' compensation claims. In particular, in late 1995 PICO
implemented a change in the manner in which it pays legal counsel for work
performed in connection with litigated claims which had the effect of
significantly reducing PICO's LAE reserves for open claims from prior years.

During 1995, PICO experienced an aggregate of approximately $3.9 million in
reserve recoveries attributable primarily to favorable development on losses and
LAE for accident years 1990 - 1994. During 1994, PICO experienced an aggregate
of approximately $4.0 million in reserve recoveries, primarily attributable to
favorable development for the 1993 accident year. PICO's reserve recoveries
during 1994 and 1995 are directly related to the more favorable loss patterns
experienced by PICO in 1993 and 1994 compared with those anticipated by PICO
based on the patterns exhibited during 1990 - 1992. PICO recognized the
favorable development associated with the California reforms and related fraud
abatement activities in the early 1990's over time as more credible loss
development information became available confirming the existence of a favorable
trend.

During the six months ended June 30, 1997, PICO recorded losses and LAE of
$28.1 million, consisting of paid losses and LAE of $18.9 million and an
increase in reserves for losses and LAE for 1997 and all prior years of $9.2
million. The 1997 increase in reserves is net of recoveries of an aggregate of
approximately $0.8 million of reserves for accident years 1991 - 1993.

POLICYHOLDER DIVIDENDS

Workers' compensation policies can be written on a participating or
non-participating basis. Participating policies allow the Company to declare and
pay dividends to a policyholder after the expiration of the policy based upon a
policyholder's specific loss experience (or, if the policyholder is part of a
safety group, the group's specific loss experience), the Company's overall loss
experience and competitive conditions. Since January 1, 1997, substantially all
workers' compensation insurance underwritten by the Company in California,
Alaska and Texas has been written on non-participating policy forms.
Substantially all of the insurance underwritten by the Company in Arizona,
Oregon, Idaho and Florida is written on participating policy forms. Currently,
workers' compensation insurers in Arizona and Florida generally use policyholder
dividends to reward favorable loss experience as a means of competitive pricing.
In Oregon and Idaho, dividends are sometimes used as a competitive pricing tool,
although rates are more flexible in those states. Dividends play little role in
Alaska and Texas, due to the flexibility in the rating plans in those states.
The Company makes the determination of the amount of the dividends it chooses to
pay on its participating policies generally 12 to 30 months after policy
expiration, and such payments require approval by PICO's board of directors. The
Company intends to continue to issue policies in Arizona, Oregon, Idaho and
Florida that are eligible for policyholder dividend consideration.

REINSURANCE

Insurance risk is ceded primarily to reduce the liability on individual
claims and to protect against catastrophic losses. The Company follows the
industry practice of reinsuring a portion of its risks on an excess of loss
reinsurance basis. For this coverage, the Company pays the reinsurer a portion
of the premiums received on all policies. In return, the reinsurer agrees to
reimburse the Company for all losses in excess of a predetermined amount,
commonly referred to as the insurance company's retention.

The Company maintains excess of loss reinsurance treaties with various
reinsurers for workers' compensation. Since 1974, GenRe has been the Company's
primary reinsurer. GenRe is currently assigned a letter rating of "A++
(Superior)" by A.M. Best. The Company's upper layers of reinsurance

48
<PAGE>
coverage are currently provided by a group of 15 companies contracted through a
reinsurance intermediary owned by GenRe. All such carriers are currently
assigned a rating of "A-" or better by A.M. Best. Reinsurance receivables
reflected in the Consolidated Financial Statements are due from GenRe. Under the
current workers' compensation reinsurance treaties, various reinsurers assume
liability on that portion of the loss that exceeds $250,000 per accident, up to
a maximum of $30 million per accident. The Company's per accident retention was
$150,000 until October 1993 and $200,000 thereafter until July 1, 1996. An
accident is defined as a single event, whether it affects one or more persons.
Although reinsurance makes the assuming reinsurer liable to PICO to the extent
of the reinsurance ceded, it does not legally discharge PICO from its primary
liability for the full amount of the policy liability. The Company has
encountered no disputes with its reinsurers and has not experienced any
difficulty on the part of reinsurers to fulfill their obligations under
reinsurance treaties. The Company believes that suitable alternative reinsurance
treaties are readily obtainable at the present time.

INVESTMENTS AND INVESTMENT RESULTS

The Company employs a conservative investment strategy emphasizing asset
quality and the matching of maturities of its fixed maturity investments to the
Company's anticipated claim payments and expenditures or other liabilities. The
Company employs Conning Asset Management Company ("Conning Asset Management") to
act as its independent investment advisor pursuant to the terms of a written
agreement with Conning Asset Management and the Company's written investment
guidelines.

Conning Asset Management has discretion to enter into investment
transactions within the Company's investment guidelines. In practice, this
discretion is generally exercised only with respect to the reinvestment of
maturing securities in similar securities. In the case of sales of securities
prior to maturity, or the acquisition of securities which differ from the types
of securities already present in the portfolio, Conning Asset Management will
routinely consult with the Company's Chief Financial Officer, who chairs the
Company's investment committee, prior to entering into such transactions. Among
other things, Conning Asset Management seeks to match the average duration of
the portfolio's assets with the estimated average duration of the Company's
liabilities. Conning Asset Management's fee is based on the amount of assets in
the portfolio and is not dependent upon investment results or portfolio
turnover. Conning Asset Management is affiliated with one of the Company's
principal stockholders. See "Certain Transactions".

The amount and types of investments that may be made by the Company's
insurance subsidiaries are regulated under the California Insurance Code and
related rules and regulations promulgated by the California DOI. Subject to such
applicable state laws and regulations, investment policies and investment
decisions are approved by the Company's investment committee and are reviewed by
the Board of Directors. The Company modifies its mix of tax-exempt and taxable
securities from time to time based in large part on effective after-tax yield
considerations. Management intends to hold all of the Company's fixed maturity
investments for indefinite periods of time but these investments are available
for sale in response to changes in interest rates, tax planning considerations
or other aspects of asset/liability management.

49
<PAGE>
As of June 30, 1997, the carrying value of the Company's investment
portfolio was approximately $93.4 million and amortized cost was approximately
$92.1 million. The diversification of the Company's investment portfolio as of
December 31, 1996 and June 30, 1997 is shown in the table below:

CONSOLIDATED INVESTMENT POSITION

<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996 AS OF JUNE 30, 1997
----------------------------------- -----------------------------------
<S> <C> <C> <C> <C> <C> <C>
PERCENT OF PERCENT OF
CARRYING AMORTIZED CARRYING CARRYING AMORTIZED CARRYING
TYPE OF INVESTMENT VALUE (1) COST VALUE VALUE (1) COST VALUE
- ---------------------------------------- --------- ----------- ----------- --------- ----------- -----------
(DOLLARS IN THOUSANDS)
Fixed maturities: (2)
United States government agencies and
authorities......................... $ 16,799 $ 16,619 19.4% $ 13,761 $ 13,676 14.7%
States, municipalities and political
subdivisions........................ 48,008 47,238 55.3 55,860 54,957 59.8
Corporate securities.................. 9,560 9,370 11.0 9,364 9,215 10.0
Collateralized mortgage obligations... 7,004 7,025 8.1 7,620 7,637 8.2
--------- ----------- ----- --------- ----------- -----
Total fixed maturities................ $ 81,371 $ 80,252 93.8% $ 86,605 $ 85,485 92.7%
Equity securities (3)................... 1,810 1,748 2.1 2,929 2,741 3.2
Invested cash........................... 3,611 3,611 4.1 3,845 3,845 4.1
--------- ----------- ----- --------- ----------- -----
Total investments..................... $ 86,792 $ 85,611 100.0% $ 93,379 $ 92,071 100.0%
--------- ----------- ----- --------- ----------- -----
--------- ----------- ----- --------- ----------- -----
</TABLE>

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

(1) All securities are carried at market value except invested cash is carried
at cost, which approximates market value.

(2) All fixed maturity securities have been designated as available for sale.

(3) Excludes the Company's minority investments in Parker and CAPAX, which had a
carrying value as of December 31, 1996 and June 30, 1997 of $1.9 million.

It is the Company's practice to purchase almost exclusively investment grade
fixed maturity securities. As of June 30, 1997, the Company did not own any
below investment grade or non-performing fixed maturity securities, or any
mortgages or real estate. As of June 30, 1997, all of the Company's fixed
maturity securities carried a NAIC Class 1 designation (or a comparable rating
agency designation).

At June 30, 1997, the Company owned a total of $7.6 million amortized cost
of AAA-rated Collateralized Mortgage Obligations ("CMOs"). The Company's
holdings of CMOs consist of Planned Amortization Class CMOs, which are
structured to have a higher degree of cash flow certainty over a variety of
prepayment scenarios, and have remaining average lives from six months to three
years.

50
<PAGE>
The following table sets forth certain information regarding the investment
ratings of the Company's fixed maturity investment portfolio as of June 30,
1997:

LONG TERM FIXED MATURITY PORTFOLIO BY STANDARD & POOR'S RATING

<TABLE>
<CAPTION>
PERCENTAGE
CARRYING AMORTIZED OF CARRYING
RATINGS (1) VALUE COST VALUE
- -------------------------------------------------------------------------- ----------- ----------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
AAA....................................................................... $ 58,903 $ 58,207 68.0%
AA........................................................................ 10,636 10,474 12.3
A......................................................................... 17,066 16,804 19.7
----------- ----------- -----
Total..................................................................... $ 86,605 $ 85,485 100.0%
----------- ----------- -----
----------- ----------- -----
</TABLE>

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

(1) Ratings assigned by S&P when available, otherwise equivalent ratings
assigned by Moody's or Fitch. S&P assigns ratings ranging from "AAA" to "D"
reflecting its current opinion of the creditworthiness of the obligor with
respect to the specific security rated. The following ratings reflect S&P's
opinion of the obligor's capacity to meet its financial commitment on the
relevant obligation: AAA-Extremely Strong; AA-Very Strong; and A-Strong.

The following table sets forth certain information regarding the maturity
profile of the Company's fixed maturity securities as of June 30, 1997 based on
the earlier of the pre-escrowed date or the scheduled maturity date:

INVESTMENT PORTFOLIO BY YEARS TO MATURITY

<TABLE>
<CAPTION>
PERCENTAGE OF
MATURITY CARRYING VALUE CARRYING VALUE
- -------------------------------------------------------------------------------- --------------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
One year or less................................................................ $ 10,993 12.7%
After one year through five years............................................... 48,979 56.5
After five years through ten years.............................................. 19,013 22.0
Mortgage and asset backed securities (1)........................................ 7,620 8.8
--------------- -----
Total........................................................................... $ 86,605 100.0%
--------------- -----
--------------- -----
</TABLE>

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

(1) Mortgage-backed securities generally are more likely to be prepaid than
other fixed maturity securities. Therefore, contractual maturities are
excluded from this table since they may not be indicative of actual
maturities.

51
<PAGE>
The Company's investment results for each of the three years ended December
31, 1994, 1995 and 1996 and for the six months ended June 30, 1997 were as
follows:

INVESTMENT PORTFOLIO RESULTS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------- SIX MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
--------- --------- --------- ------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Net pre-tax investment income (1)......................... $ 4,536 $ 4,817 $ 4,701 $ 2,499
Average total invested assets (2)......................... 82,858 82,851 83,644 88,840
Annual pre-tax yield on average total invested assets
(3)..................................................... 5.5% 5.8% 5.6% 5.6%
Net pre-tax realized investment gains..................... $ -- $ 37 $ 444 $ --
</TABLE>

- --------------
(1) Calculated net of investment expenses and excluding capital gains and losses
and provision for income taxes.

(2) Calculated based on an average of the beginning and end of period total
investments. For the purpose of this calculation, investment balances were
at cost (fixed income securities at amortized cost).

(3) Pre-tax yield is calculated as investment income (including dividend income
in the case of equities) divided by average total invested assets. The yield
for the six months ended June 30, 1997 is on an annualized basis.

The following table summarizes net investment income from the Company's
portfolio for the years ended December 31, 1994, 1995 and 1996 and for the six
months ended June 30, 1997:

NET INVESTMENT INCOME BY INVESTMENT TYPE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------------------
1994 1995 1996
--------------------------------------- ----------------------------------------- --------------------------
% REALIZED % REALIZED %
PRE-TAX GAINS PRE-TAX GAINS PRE-TAX
INCOME YIELD (1) (LOSSES) INCOME YIELD (1) (LOSSES) INCOME YIELD (1)
----------- ------------- ----------- ----------- ------------- ------------- ----------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed maturity
securities:
Tax-exempt (2)... $ 1,868 4.4% $ 16 $ 2,383 5.1% $ (10) $ 2,660 5.5%

Taxable.......... 2,384 6.4 -- 2,302 7.0 47 1,841 6.0

Equities (3)....... 87 10.9 (16) 51 6.9 -- 62 5.8

Short-term......... 417 8.4 -- 278 5.9 -- 338 8.6
----------- ----------- ----------- --- -----------

Total............ $ 4,756 5.7% $ -- $ 5,014 6.1% $ 37 $ 4,901 5.9%
----------- ----------- ----------- --- -----------

Less investment
expense.......... 220 -- 197 -- 200
----------- ----------- ----------- --- -----------

Total............ $ 4,536 5.5% $ -- $ 4,817 5.8% $ 37 $ 4,701 5.6%
----------- ----------- ----------- --- -----------
----------- ----------- ----------- --- -----------

SIX MONTHS ENDED
JUNE 30, 1997
-------------------------------------
REALIZED % REALIZED
GAINS PRE-TAX GAINS
(LOSSES) INCOME YIELD (1) (LOSSES)
------------- ----------- ----------- -----------

<S> <C> <C> <C> <C>
Fixed maturity
securities:
Tax-exempt (2)... $ 248 $ 1,234 4.8% $ --
Taxable.......... 196 1,018 6.4 --
Equities (3)....... -- 74 6.6 --
Short-term......... -- 266 13.0 --
----- ----------- -----------
Total............ $ 444 $ 2,592 5.8% $ --
----- ----------- -----------
Less investment
expense.......... -- 93 --
----- ----------- -----------
Total............ $ 444 $ 2,499 5.6% $ --
----- ----------- -----------
----- ----------- -----------
</TABLE>

- ------------------
(1) Pre-tax yield is calculated as investment income (including dividend income
in the case of equities) divided by the average of the beginning and end of
year investment balances. For the purpose of this calculation, investment
balances were at cost (fixed income securities at amortized cost). The
yields for the six months ended June 30, 1997 are on an annualized basis.

(2) For purposes of comparison to yields on taxable securities, those yields on
tax-exempt securities are equivalent to average pre-tax yields of 5.6% for
1994, 6.5% for 1995, 7.1% for 1996, and 6.2% for the six months ended June
30, 1997 assuming that the tax rate was 34% and further assuming that 15% of
a portion of the tax-exempt interest was subject to federal income tax under
certain provisions applicable only to insurance companies.

(3) Excludes the Company's minority investments in Parker and CAPAX, which had a
carrying value as of June 30, 1997 of $1.9 million.

52
<PAGE>
REGULATION

GENERAL

PAULA Financial and its subsidiaries are subject to regulation by the
departments of insurance in each jurisdiction in which they transact insurance.
These departments of insurance have broad regulatory, supervisory and
administrative powers over the insurance subsidiaries. Primary regulatory
authority, however, rests with the California DOI, the regulator in the
Company's insurance subsidiaries' state of domicile. While the exercise of their
authority may have company-wide ramifications, regulators in non-domiciliary
states focus primarily on the operation of an insurer within their respective
states.

State insurance regulation is generally intended for the benefit and
protection of policyholders and claimants under insurance policies rather than
stockholders. The nature and extent of such regulation varies from jurisdiction
to jurisdiction, but typically involve: (i) standards of solvency and minimum
amounts of capital and surplus which must be maintained; (ii) limits on types
and amounts of investments; (iii) restrictions on the size of risks which may be
insured by a single company; (iv) licensing of insurers and their agents; (v)
required deposits of securities for the benefit of policyholders; (vi) approval
of policy forms; (vii) establishment of statutory reporting practices and the
form and content of statutory financial statements; (viii) establishment of
methods for setting statutory loss and expense reserves; (ix) review, and in
certain instances prior-approval, of premium rates; (x) limits on transactions
among insurers and their affiliates; (xi) approval of all proposed changes of
control; (xii) approval of dividends; (xiii) setting and collecting guarantee
fund assessments; and (xiv) required filing of annual and other reports with
respect to the financial condition and operation of insurers. In addition, state
regulatory examiners perform periodic financial and underwriting examinations of
insurers.

DOMICILE AND LICENSING

PICO and PACO are domiciled in California. PICO is licensed to transact
insurance in Alaska, Arizona, California, Florida, Idaho, New Mexico, Oregon and
Texas. PACO is licensed to transact insurance in Arizona and California. PICO
and PACO may seek to become licensed in additional states.

RESTRICTIONS ON ACQUISITIONS OF CONTROL

The California Insurance Code provides that any direct or indirect
acquisition or change in "control" of a domestic insurer cannot be consummated
without the prior approval of the California DOI. The California Insurance Code
provides further that, unless the California DOI upon application determines
otherwise, a presumption of "control" arises from the ownership, control,
possession with the power to vote or possession of proxies with respect to 10%
or more of the voting securities of a domestic insurer or of a person or entity
that controls a domestic insurer.

Any person who purchases in this offering, or through any other transaction,
shares of the Common Stock which, when combined with all other voting securities
owned or otherwise controlled by that person, total 10% or more of the voting
securities of the Company, will be deemed to have acquired control of the
insurance subsidiaries unless the California DOI, upon application determines
otherwise. Any such acquisition of control is prohibited under the California
Insurance Code unless prior approval of the California DOI is obtained or the
California DOI does not disapprove the acquisition within 60 days after an
application has been filed. The California DOI is authorized to disapprove any
acquisition which (i) would cause the insurance subsidiaries to cease to qualify
for their licenses to transact insurance, (ii) would substantially lessen
competition or tend to create a monopoly, (iii) might, due to the financial
condition of the acquiring person, jeopardize the financial stability of the
insurance subsidiaries or prejudice the interests of their policyholders, (iv)
would result in a major change in the insurance subsidiaries' business or
corporate structure or management which is not fair and reasonable to
policyholders, or (v) would result in control over the insurance subsidiaries by
persons whose competence, experience and integrity indicate that it is not in
the interest of policyholders or the public to permit them to assume control.

53
<PAGE>
The need for such action, and the possibility of disapproval by the
California DOI, could deter, delay or prevent certain transactions affecting the
control of the Company or the ownership of the Company's Common Stock. Since the
statutory disapproval criteria focus primarily on policyholder, rather than
stockholder, interests, these requirements could deter, delay or prevent
transactions which could be advantageous to the stockholders of the Company.

RESTRICTIONS ON STOCKHOLDER DIVIDENDS PAYABLE BY THE INSURANCE SUBSIDIARIES TO
THE COMPANY

PAULA Financial, as a non-insurer, is generally not restricted directly
under applicable insurance laws with respect to the payment of dividends to
stockholders or the acquisition of non-regulated businesses. PAULA Financial,
however, is subject to regulation with respect to all transactions involving the
insurance subsidiaries. Additionally, as a nonoperating holding company, a
principal source of the PAULA Financial's liquidity is cash dividends received
from its subsidiaries, including the insurance subsidiaries.

RESTRICTIONS ON TRANSACTIONS AMONG AFFILIATES OF THE INSURANCE SUBSIDIARIES

In addition to dividend restrictions, California law restricts the ability
of the insurance subsidiaries to make other types of payments to their
affiliates, including PAULA Financial. Certain material transactions between an
insurance company and its affiliates, including sales, loans or investments
which in any twelve month period aggregate at least 3% of its admitted assets or
25% of policyholders' surplus, whichever is less, are subject to thirty day
prior notice to the California DOI during which period the California DOI may
disapprove the transaction. All management, administrative, cost-sharing and
similar agreements between an insurance company and its affiliates are also
subject to thirty day prior notice and non-disapproval by the California DOI.
The California Insurance Code requires that all affiliate transactions be fair
and reasonable to the insurer, that such transactions be documented according to
specified standards, and that the insurer's surplus after the transaction
remains reasonable in relation to the insurer's liabilities and adequate to its
financial needs.

EXAMINATIONS

The accounts and businesses of PICO and PACO are subject to periodic
statutory examination by the California DOI and by the Departments of Insurance
in each jurisdiction in which they transact business. The California DOI has
completed its examination of PICO and PACO for the three-year period ended
December 31, 1993. The report disclosed no material problems or adjustments to
statutory

54
<PAGE>
surplus. PICO is currently undergoing a routine statutory examination for the
three-year period ended December 31, 1996. While the examination is not yet
complete, the California DOI has not indicated to PICO's management the
existence of any material deficiency. In addition, the Internal Revenue Service
has requested information from the Company relating to a net operating loss
carryback with regard to its 1995 federal income tax return. The Company
supplied the requested information and the Service has not advised the Company
of any disagreements over the matter.

NAIC STATUTORY ACCOUNTING INITIATIVE

The NAIC currently has a project to codify accounting practices that is
likely to change the definition of what constitutes prescribed versus permitted
statutory accounting practices and may result in changes to the accounting
policies that insurance enterprises use to prepare their statutory financial
statements. The Company is unable to predict how such project will affect its
insurance subsidiaries' statutory financial statements or how insurance rating
agencies will interpret or react to any such changes. No assurance can be given
that future legislative or regulatory changes resulting from such activities
will not adversely affect the Company and its subsidiaries.

RISK-BASED CAPITAL AND IRIS RATIOS

California, as well as numerous other states, uses analytical tools
developed by the NAIC in the course of its financial surveillance of insurers.
Among these is a recently developed methodology for assessing the adequacy of
statutory surplus of property/casualty insurers and life/health insurers using a
risk-based capital ("RBC") formula. The RBC formula attempts to measure
statutory capital and surplus needs based on the risks in a company's mix of
products and investment portfolio. The formula is designed to allow state
regulators to identify potentially under-capitalized companies. Under the
formula, a company determines its RBC by taking into account certain risks
related to the insurer's assets (including risks related to its investment
portfolio and ceded reinsurance) and the insurer's liabilities (including
underwriting risks related to the nature and experience of its insurance
business). The RBC rules provide for different levels of regulatory attention
depending upon the ratio of the company's total adjusted capital to its
"authorized control level" of RBC. An insurer is obligated to submit a detailed
financial plan to regulators if its RBC falls below 2.0 times its authorized
control level. Enhanced regulatory scrutiny, including possible corrective
orders, are required if an insurer's RBC falls below 1.5 times its authorized
control level, with mandatory regulatory intervention, including possible
seizure, if an insurer's RBC falls below its authorized control level (seizure
is mandatory if RBC falls below 0.7 times authorized control level). As of
December 31, 1996, PICO's RBC was $27.8 million in excess of the threshold
requiring the least regulatory attention, which amount was $3.3 million. As of
December 31, 1996, PACO's RBC was $3.9 million in excess of the threshold
requiring the least regulatory attention, which amount was $0.1 million. Neither
PICO nor PACO has ever triggered any RBC level requiring a financial plan or
regulatory action.

California and other states also utilize the NAIC Insurance Regulatory
Information System ("IRIS"). IRIS identifies eleven ratios for property/casualty
insurance companies and twelve ratios for life/health insurance companies. IRIS
specifies a range of "usual values" for each ratio. No statutory requirements
exist which determine regulators' response to unusual IRIS ratios. Regulators
generally allow insurers to provide written explanations for any unusual values.
If the explanations are accepted as reasonable, no regulatory action is
generally taken. If regulators remain concerned, an insurer may be subject to
regulatory examination, corrective orders, and possible seizure. Departure from
the "usual value" range on four or more ratios may lead to increased regulatory
oversight from individual state insurance commissioners. In 1996, PICO had one
ratio outside its usual value, which was caused by excess premium growth. The
range for this ratio is (-33%) to 33%. PICO experienced a 36% growth in 1996. In
1996, PACO had three ratios outside their usual values, which were caused by (i)
206% premium growth,

55
<PAGE>
(ii) change in product mix of 9.9% and (iii) excess adequacy of investment
income. PICO and PACO are unaware of any increased regulatory scrutiny as a
result of their 1996 IRIS values.

REGULATION OF PICO'S BUSINESS IN EACH STATE IN WHICH IT IS LICENSED

PICO's transaction of workers' compensation insurance is closely regulated
by departments of insurance in Alaska, Arizona, California, Florida, Idaho, New
Mexico, Oregon and Texas. In each of these states, the workers' compensation
system is a mechanism to promptly compensate and rehabilitate injured workers
without regard to fault. In each state where PICO is licensed, other than New
Mexico (with respect to agricultural workers) and Texas, employer participation
in the workers' compensation system is compulsory. Employers are required by law
either to obtain workers' compensation insurance from a licensed insurer or to
comply with specific requirements to self-insure.

Workers' compensation benefits are established by law in each of the states
where PICO is licensed. While benefit levels vary from state to state, they fall
generally into three categories: (1) medical benefits for treatment of covered
injuries or diseases; (2) disability benefits that indemnify covered claimants
for loss of income, and (3) death benefits to compensate statutorily enumerated
dependents of workers who have died because of covered accidents or diseases.
Individual state statutes, regulations, administrative rulings and judicial
opinions have created a complex body of law to determine when an injury, disease
or death is employment related, when and to what extent it is compensable, and
whether employees may sue employers, coworkers or other parties for damages
outside of the no-fault workers' compensation system.

Workers' compensation has been the subject of significant reform efforts in
recent years, particularly in the areas of cost management and fraud detection.
For example, legislation enacted in California in 1993 significantly reformed
many areas of the workers' compensation system. Among other things, the 1993
legislation (i) granted employer's rights regarding disclosure of insurer claims
information; (ii) required insurers to provide minimum levels of occupational
safety and health loss control consultation services; (iii) increased benefits,
phased in over a three-year period commencing July 1, 1994; (iv) tightened
standards relating to stress-related claims; (v) limited post-termination
claims; (vi) placed restrictions, including payment limitations, on vocational
rehabilitation claims, (vii) increased measures to reduce fraudulent claims;
(viii) increased the ability of insurance companies and employers to contract
with managed care organizations and to direct claimants' medical care; and (ix)
changed procedures for medical-legal evaluations. Similarly, legislation adopted
in Oregon in 1995, among other things, reformed requirements pertaining to
pre-existing conditions, vocational rehabilitation, payment of death benefits,
review of benefit awards and dispute resolution.

To protect persons covered under policies of workers' compensation
insurance, several states impose special deposit requirements on insurers. In
the event of an insurer insolvency, special deposits made by insurers are
utilized by the relevant department of insurance to provide a pool of funds upon
which workers' compensation claimants domiciled exclusively in that state
possess a first priority claim and can be used by the regulators to pay those
claimants. Under these requirements, PICO maintains special deposits in Arizona,
California, Idaho, Oregon and New Mexico. Additional special deposits may be
required if PICO becomes licensed in additional states, or if Alaska, Florida or
Texas enact deposit requirements.

While deposit requirements vary somewhat, they generally require insurers to
deposit cash or securities with each states' treasurer, or an approved
depository, in an amount based on a company's loss and loss expense reserves
plus a percentage of its unearned premium reserves on workers' compensation
insurance business transacted in each individual state. Thus, the size of the
required deposit correlates positively with the amount of workers' compensation
insurance sold by PICO in such state. PICO maintains deposits of securities in
California, Arizona, Oregon, Idaho and New Mexico,

56
<PAGE>
having a book value as of June 30, 1997 of $47.6 million, $14.5 million, $5.3
million, $0.3 million and $0.1 million, respectively.

An important aspect of workers' compensation insurance regulated by
individual states is the setting of premiums. Among the states where it is
currently licensed, PICO is allowed to establish its own rates under a "file and
use" system in Alaska, California and Texas. Prior approval by insurance
regulators is required for workers' compensation insurance rates in Florida, New
Mexico and Oregon. Hybrid systems exist in Arizona and Idaho, where workers'
compensation insurance rates are determined initially by the National Council on
Compensation Insurance ("NCCI"), a rating organization. Upon the request of an
individual insurer, the Arizona or Idaho DOI, as applicable, may approve rates
that deviate from those recommended by the NCCI.

Prior to January 1, 1995, California had required workers' compensation
insurers to adhere to minimum rates approved by the California DOI. Under this
system, price competition among insurers had been generally restricted to the
payment of dividends under participating policies. This system was replaced with
a file and use system, in which insurers may use any rate within 30 days after
filing it with the California DOI unless such rate is specifically disapproved.
The repeal of the former minimum rate system in California has resulted in
increased competition among workers' compensation insurers in California and has
caused a material decrease in average rates charged by PICO.

Competition among workers' compensation insurers is also affected in several
states by the presence of quasi-public workers' compensation insurance funds,
which compete against private insurers and which frequently serve as insurers of
last resort to employers unable to secure coverage elsewhere. Among the states
where PICO is licensed, active state funds exist in Arizona, California, Idaho,
New Mexico, Oregon and Texas.

REGULATION OF PACO'S BUSINESS IN EACH STATE IN WHICH IT IS LICENSED

PACO, a California-domiciled insurer, is licensed in California and Arizona.
The transaction of life and health insurance is closely regulated in these
states. Such regulation includes statutorily mandated benefits, sales
disclosures, and claims settlement requirements. In 1996, PACO wrote less than
$1.0 million in life and health premiums written in California and Arizona
combined.

MEMBERSHIP IN INSOLVENCY FUNDS AND ASSOCIATIONS

The Company's insurance subsidiaries, like other insurers, are required to
participate in insolvency funds and associations and may be subject to
assessments from time to time to cover unpaid policyholder claims of insolvent
insurers participating in the same lines of business as the Company. The maximum
assessment required by law in any one year has varied between 1% and 2% of
annual premiums written in that state. Most of these payments are recoverable
through future policy surcharges and premium tax reductions. No material
assessments have been made on the Company's insurance subsidiaries since prior
to December 31, 1990.

COMPETITION

The workers' compensation insurance industry is highly competitive. Although
there are 260 companies licensed to write workers' compensation insurance
policies in California, the 20 largest companies accounted for more than 79% of
the workers' compensation premiums written in California during 1996 (source:
A.M. Best, State/Line Report, Property/Casualty, 1997 Edition). In each state in
which the Company operates, the Company's single largest competitor in its
targeted agricultural markets is the applicable state fund.

57
<PAGE>
Periodically, the Company competes with alternative risk funding
arrangements such as self-insurance or captive insurance programs. Captive
insurance companies are insurance or reinsurance companies in which an insured
or a group of insureds holds significant ownership. Employers have the option of
self insuring against workers' compensation liabilities. Normally, those
companies who choose to self insure are very large employers and are not among
the targeted insurance underwriting prospects of the Company.

In those states without minimum premium laws, such as California, Oregon,
Idaho, Alaska and Texas, the Company faces competition on the basis of price as
well as on the services which it delivers to policyholders. As a result of
Arizona's single deviated rate plan and Florida's minimum rate law, there has
been no significant price competition in those states in terms of premiums
charged. Competition among workers' compensation insurance carriers in those
states has been based in large part on emphasizing dividends to policyholders,
loss control and claims management services and maintaining relations with and
varying commission rates paid to brokers and agents. The Company believes that
its ability to compete successfully with larger carriers and to obtain and
retain its accounts is due to its claims expertise, extensive experience in the
agribusiness market and emphasis on service to policyholders. See "Risk
Factors--Competition".

EMPLOYEES

As of June 30, 1997, the Company employed approximately 250 full-time
employees including 78 in its agency and TPA operations, 165 in its underwriting
operations and six in corporate administration and finance. The Company
considers its relationship with its employees to be excellent. All employees
with at least one year of service are eligible to participate in the ESOP except
for those employees employed on an hourly basis. See "Management--Employee Stock
Ownership Plan".

FACILITIES

The Company's principal executive offices, comprised of approximately 34,000
square feet of office space leased through April 1999, are located in Pasadena,
California. The Company holds an option to extend its home office lease through
April 2004. In addition, the Company maintains 20 branch offices in various
locations in the western United States and Florida in leased facilities with
various lease terms. Management believes that the Company's facilities are
suitable and adequate for their intended uses.

LEGAL PROCEEDINGS

Except for ordinary, routine litigation incidental to the Company's
business, there are no pending legal proceedings to which the Company is a party
or which any of its properties are subject. The nature of the Company's business
subjects it to claims or litigation relating to policies of insurance it has
issued. Management believes that the Company is not a party to, and none of its
properties is the subject of, any pending legal proceedings which are likely to
have a material adverse effect on its business, financial conditions or results
of operations.

58
<PAGE>
MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The following table sets forth certain information concerning the Company's
directors and executive officers:

<TABLE>
<CAPTION>
NAME DIRECTOR CLASS AGE POSITION
- -------------------------------------------- ----------------- --- --------------------------------------------
<S> <C> <C> <C>
Jeffrey A. Snider........................... III 45 Chairman, Chief Executive Officer, President
and Director of the Company and all of its
subsidiaries

Andrew M. Slavitt........................... III 30 Chief Operating Officer, Senior Vice
President and Director of the Company and
all of its subsidiaries

James A. Nicholson.......................... II 52 Chief Financial Officer, Senior Vice
President and Director of the Company and
all of its subsidiaries

Bradley K. Serwin........................... I 36 General Counsel, Senior Vice President,
Secretary and Director of the Company and
all of its subsidiaries

John B. Clinton............................. III 42 Director of the Company

Owen S. Crihfield (1)....................... II 44 Director of the Company

Jerry M. Miller (1)(2)...................... II 56 Director of the Company

Gerard Vecchio (2).......................... I 36 Director of the Company

Ronald W. Waisner (1)(2).................... I 59 Director of the Company

Victor Gloria III........................... N/A 43 Senior Vice President and Director of PICO

James M. Hannah............................. N/A 49 Vice President and Director of PICO
</TABLE>

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

(1) Member of the Executive Compensation Committee.

(2) Member of the Audit Committee.

Officers are appointed by and serve at the discretion of the Board of
Directors.

Mr. Jeffrey A. Snider has been Chairman of the Board of Directors, President
and Chief Executive Officer of the Company since December 1994. Mr. Snider
joined the Company in 1975 and served as President and Chief Executive Officer
of the Company and a member of its Board of Directors from 1984 to 1988. Mr.
Snider resigned from the Company and its Board of Directors in June 1988. From
January 1989 until July 1990, Mr. Snider served as director of the Jimmy Carter
Work Project of Habitat for Humanity International Inc. in San Diego, California
and Tijuana, Mexico. In July 1990, Mr. Snider accepted a position as the first
Executive Vice President and Chief Operating Officer of Habitat, serving in that
position until December 1993, when he returned as President and Chief Executive
Officer of the Company's insurance subsidiaries. Mr. Snider was re-elected to
the Company's Board of Directors in November 1992.

Mr. Andrew M. Slavitt has served as the Chief Operating Officer of the
Company since November 1995 and as a Senior Vice President and Director of the
Company since July 1995 when he joined

59
<PAGE>
the Company. Prior to joining the Company, Mr. Slavitt served as a consultant
with McKinsey & Company, an international management consulting firm, for two
years and prior to that time attended the Harvard Business School where he
received an M.B.A. degree in 1993. From 1988 to 1991, Mr. Slavitt worked for
Goldman, Sachs & Co. as an investment banker.

Mr. James A. Nicholson has served as a Senior Vice President and Chief
Financial Officer of the Company since April 1988. He was first elected to the
Company's Board of Directors in 1986. Mr. Nicholson has been with the Company
since 1972.

Mr. Bradley K. Serwin has served as General Counsel, Senior Vice President,
Secretary and director of the Company since March 1995 when he joined the
Company. Prior to joining the Company, Mr. Serwin practiced law for nine years
with Gibson, Dunn & Crutcher, a nationwide law firm.

Mr. John B. Clinton has served as an outside director of the Company since
August 1994 as a representative of Conning & Company, the general partner of
four partnerships, each of which is a holder of Preferred Stock. Mr. Clinton has
been a Senior Vice President of Conning & Company, an insurance asset management
and research firm, since February 1992.

Mr. Owen S. Crihfield has served as an outside director of the Company since
August 1994 as a representative of Saugatuck Capital Company, a holder of
Preferred Stock. Mr. Crihfield has been a general partner of Saugatuck Capital
Company L.P., an investment firm, for more than the last five years.

Mr. Jerry M. Miller has served as an outside director of the Company since
his election to the Board of Directors in November 1992. Mr. Miller is a
Certified Public Accountant and was an audit partner with KPMG Peat Marwick LLP
from 1974 until his retirement in 1991.

Mr. Gerard Vecchio has served as an outside director of the Company since
August 1994 as a representative of Conning & Company, the general partner of
four partnerships, each of which is a holder of preferred stock. Mr. Vecchio has
been a Vice President of Conning & Company, an insurance asset management and
research firm, since October 1992 and served as a Vice President of Firemark,
Inc., an insurance research and investment firm, from January 1992 until October
1992.

Mr. Ronald W. Waisner has served as an outside director of the Company since
his election to the Board of Directors in November 1992. Prior to his retirement
in 1991, Mr. Waisner worked for Continental Insurance Company beginning in 1959.
His last position with Continental prior to retirement was Senior Vice President
and Regional Manager of the Pacific Region responsible for insurance operations
and marketing. He has served on the Boards of Directors of National Automobile
Club, California Insurance Guarantee Association, Maryland Fair Plan and the
Maryland Auto Insurance Fund.

Mr. Victor Gloria has been with the Company since 1972 and has served in
PICO's Workers' Compensation Claims Department for the majority of that time. He
has served as Manager of that Department since 1987 and was appointed Senior
Vice President of PICO in 1987. Mr. Gloria has obtained the certificated
designation of Associate in Claims. Mr. Gloria was first elected to the PICO
Board of Directors in April 1987.

Mr. James M. Hannah joined the Company in March 1995, assuming the position
of Vice President and Chief Underwriting Officer of PICO. Prior to joining the
Company, Mr. Hannah served as Vice President of American Home Assurance Co., a
property and casualty insurance company, Manager of New Hampshire Insurance Co.
from January 1993 to November 1993 and as Vice President of SAIF Corporation,
the Oregon State insurance fund, for nine years prior to that time. Mr. Hannah
was first elected to the PICO Board of Directors in April 1995.

Messrs. Clinton, Crihfield and Vecchio were nominated to the Board of
Directors pursuant to the terms of the Series A Preferred Stock Purchase
Agreement entered into in connection with the Company's offering of Preferred
Stock. See "Certain Transactions".

60
<PAGE>
The Board of Directors currently has an Audit Committee comprised of Messrs.
Miller, Vecchio and Waisner; an Executive Compensation Committee comprised of
Messrs. Crihfield, Miller and Waisner; an Executive Committee comprised of
Messrs. Snider, Slavitt, Nicholson and Serwin; and a Capital Finance Committee
comprised of Messrs. Snider, Slavitt, Nicholson and Serwin.

STAGGERED BOARD OF DIRECTORS

The Board of Directors has nine members. Pursuant to the Company's Bylaws,
the Board is divided into three classes. Class I Directors serve for a term
ending at the first annual meeting held after the date of the Company's
reincorporation in Delaware (the "Incorporation Date"), Class II Directors serve
for a term ending at the second annual meeting held after the Incorporation
Date, and Class III Directors serve for a term ending at the third annual
meeting held after the Incorporation Date.

COMPENSATION OF DIRECTORS

Each member of the holding company's Board of Directors who is not an
employee of the Company or any of its subsidiaries receives a director fee of
$10,000 per year, plus a $500 fee per meeting and has received a grant of stock
options and is eligible for grants under the Company's 1997 Stock Incentive
Plan. See "--Stock Incentive Plans". These directors are reimbursed for
out-of-pocket expenses reasonably incurred for attending meetings. It is
expected that at least four board meetings will be held during each calendar
year.

61
<PAGE>
EXECUTIVE COMPENSATION

The following table sets forth summary information regarding the annual and
long-term compensation for services in all capacities to the Company for the
three years ended December 31, 1996 for those persons who were, as of December
31, 1996, the Chief Executive Officer and the four other most highly compensated
named officers of the Company who received in excess of $100,000 for the year
ended December 31, 1996 (the "Named Executive Officers"):

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
AWARDS
------------------------ ALL
ANNUAL COMPENSATION RESTRICTED SECURITIES OTHER
------------------------ STOCK UNDERLYING COMPEN-
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) AWARDS ($) OPTIONS (#) SATION (1)
- ---------------------------------------- --------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Jeffrey A. Snider....................... 1996 $ 250,000 $ 25,000(2) $ -- 300,000 $ 25,347
Chairman of the Board, Chief Executive 1995 250,000 -- -- -- 24,440
Officer, and President 1994 183,000 50,000 -- 100,000 5,925

Andrew M. Slavitt....................... 1996 145,000 10,000(2) 23,640 114,000 5,050
Chief Operating Officer (3) 1995 73,000 31,500 -- 20,000 --
1994 -- -- -- -- --

James A. Nicholson...................... 1996 180,000 10,000(2) -- 23,000 8,190
Chief Financial Officer 1995 180,000 -- -- -- 7,469
1994 164,000 50,000 -- 40,000 7,201

Bradley K. Serwin....................... 1996 135,000 10,000(2) 15,760 57,000 5,936
General Counsel (4) 1995 102,500 27,000 -- -- --
1994 -- -- -- -- --

Victor Gloria III....................... 1996 126,000 40,000 15,760 26,000 7,590
Senior Vice President--Claims 1995 123,500 25,000 -- -- 5,939
Administration 1994 113,000 45,000 10,836 1,200 5,344
</TABLE>

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

(1) Amounts in this column consist of contributions by the Company to the ESOP,
matching contributions to the PAULA Financial and Subsidiaries 401K
Retirement Savings Plan and split dollar life insurance paid by the Company
on behalf of the Named Executive Officers.

(2) Since January 1, 1996, the annual bonuses paid to Messrs. Snider, Slavitt,
Nicholson and Serwin have been determined and paid in March of the year
following the year to which the bonus relates since the bonus is based on
company-wide results for the previous year. Bonuses paid in 1996 related to
1995 results. Bonuses paid to such persons in 1997 were $175,000, $80,000,
$50,000 and $45,000, respectively.

(3) Mr. Slavitt joined the Company in July 1995.

(4) Mr. Serwin joined the Company in March 1995.

62
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR

The following table provides information with respect to stock options
granted during the year ended December 31, 1996 to the Named Executive Officers:

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
-------------------------------------------------------- VALUE AT ASSUMED
NUMBER OF PERCENT OF ANNUAL RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION ----------------------------
NAME GRANTED (#) FISCAL YEAR SHARE ($) DATE 5% ($) 10% ($)
- -------------------------------------- ------------ ----------------- ----------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Jeffrey A. Snider..................... 50,000 8.3% $ 7.88 02/01/06 $ 247,784 $ 627,935
250,000 41.3 9.50 10/26/06 1,493,625 3,785,138
Andrew M. Slavitt..................... 20,000 3.3 7.88 02/01/06 99,114 251,174
94,000 15.5 9.50 10/26/06 561,603 1,423,212
James A. Nicholson.................... 15,000 2.5 7.88 02/01/06 74,335 188,380
8,000 1.3 9.50 10/26/06 47,796 121,124
Bradley K. Serwin..................... 15,000 2.5 7.88 02/01/06 74,335 188,380
42,000 6.9 9.50 10/26/06 250,929 635,903
Victor Gloria III..................... 10,000 1.7 7.88 02/01/06 49,557 125,587
16,000 2.6 9.50 10/26/06 95,592 242,249
</TABLE>

FISCAL YEAR-END OPTION VALUES

The following table contains certain information regarding options to
purchase shares of Common Stock held as of December 31, 1996 by each of the
Named Executive Officers. None of such Named Executive Officers exercised any
options during 1996.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL IN-THE-MONEY OPTIONS AT
YEAR-END (#) FISCAL YEAR-END ($) (1)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------------------------------- ------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Jeffrey A. Snider.................................... 212,500 187,500 $ 463,625 $ 249,375
Andrew M. Slavitt.................................... 63,500 70,500 126,255 93,765
James A. Nicholson................................... 57,000 6,000 140,110 7,980
Bradley K. Serwin.................................... 25,500 31,500 58,215 41,895
Victor Gloria III.................................... 14,480 12,720 35,684 17,256
</TABLE>

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

(1) Based on the fair market value of the Common Stock as of December 31, 1996
(as determined by an independent valuation firm) less the exercise price
payable for such shares.

STOCK INCENTIVE PLANS

The Board of Directors and Stockholders of the Company have adopted the 1994
Stock Incentive Plan (the "1994 Plan") and the 1997 Stock Incentive Plan (the
"1997 Plan" and, collectively with the 1994 Plan, the "Plans") pursuant to which
officers, directors, employees and independent consultants of the Company or any
of its subsidiaries or affiliates are eligible to receive options and other
awards tied to the value of the Common Stock. The purpose of the Plans is to
enable the Company to attract, retain and motivate employees by providing for or
increasing their proprietary interests in the Company and, in the case of
non-employee directors and consultants, to attract such directors and key
consultants and further align their interests with those of the Company's
stockholders by providing for or increasing their proprietary interest in the
Company. Of the 550,000 shares of Common Stock authorized for grant under the
1994 Plan, 25,250 shares were available for grant as of June 30, 1997. All of
the 200,000 shares of Common Stock authorized for grant under the 1997 Plan were
available for grant as of June 30, 1997.

63
<PAGE>
The 1994 Plan is administered by a committee of three disinterested,
non-employee directors appointed by the Board of Directors of the Company (the
"Committee"), except that grants to non-employee directors will be made by the
Board of Directors pursuant to a predetermined formula. The 1997 Plan is also
administered by the Committee, but no predetermined grants will be made under
the 1997 Plan. The Committee has final and conclusive authority to select the
employees, directors and consultants to receive awards and to grant such awards.
Subject to the provisions of the Plans, the Committee has a wide degree of
flexibility in determining the terms and conditions of awards, including the
number of shares to be issued pursuant thereto, the exercise price thereof and
conditioning the receipt or vesting of awards upon achievement by the Company of
specified performance criteria.

OTHER MANAGEMENT STOCK OPTIONS

In addition to awards available for grant under the Plans, the Company has
granted options to purchase an aggregate of 376,000 shares of Common Stock to
eight executive officers and directors of the Company. These grants were made
pursuant to written agreements with terms substantially similar to those set
forth in the Plans.

EMPLOYEE STOCK OWNERSHIP PLAN

The Company and each of its subsidiaries has adopted the ESOP. The ESOP was
established for the benefit of all of the employees of the Company and each of
its subsidiaries who have completed one year of service with the Company or its
subsidiaries except for those employees who are paid on an hourly basis (each,
an "Eligible Employee"). The ESOP is intended to qualify under Sections 401(a)
and 4975(e)(7) of the Internal Revenue Code of 1986, as amended (the "Code").

The ESOP provides that the amount of the contribution by the Company and
each of its subsidiaries each year is discretionary with the Board of Directors
of each separate corporation. Under the terms of the ESOP, neither the Company
nor any of its subsidiaries is obligated to make any contribution to the ESOP
for any year. However, in practice, the Company's contribution to the ESOP each
year has been not less than the amount, if any, needed to provide the ESOP with
sufficient cash assets to permit the ESOP to meet its distribution obligations
to plan participants and, when shares of the Company's stock have been
distributed instead of cash, to meet its repurchase obligations for stock
reacquired by it from terminated plan participants.

Contributions to the ESOP by the Company and its subsidiaries are allocated
among plan participants who are employed as Eligible Employees on the last day
of the year in the same ratio to the total contribution as each such
participant's units for the year bear to the total units of all participants
entitled to share in the allocation. Under the ESOP, each participant receives
units based on their compensation during the year, subject to specified
limitations, and their years of service.

Separate accounts are maintained for each participant in the ESOP. Each
participant's benefits become fully vested upon termination of employment due to
death, disability (as defined in the ESOP) or attainment of normal retirement
age (as defined in the ESOP). Otherwise, participants become vested based on
their years of service in accordance with the following schedule:

<TABLE>
<CAPTION>
YEARS OF PERCENTAGE
SERVICE VESTED
- --------------- ---------------
<S> <C>
1........... 10%
2........... 20
3........... 30
4........... 40
5........... 60
6........... 80
7........... 100
</TABLE>

64
<PAGE>
The ESOP is designed so that the Trustee may invest the trust assets
primarily in shares of the Company's Common Stock which meets the definition of
"Employer Securities" as set forth in Section 409(e) of the Code. As of December
31, 1996, the ESOP held assets having an overall value of approximately $14.2
million. Among these assets were 1,094,126 shares of Common Stock having an
aggregate fair market value, as determined by the ESOP's independent appraisal
firm, of $11.8 million, as of December 31, 1996.

When a participant terminates employment with the Company or a subsidiary,
he will receive a distribution of his account balance. The distribution will
normally be made to the participant as soon as it is administratively feasible
during the plan year following the plan year in which the participant incurs a
break in service. A break in service is a plan year during which the participant
is credited with less than 501 hours of service. The distribution will either be
in cash or shares of Common Stock, with each participant having the right to
demand that his distribution be made in shares of Common Stock. If a Participant
receives a distribution of shares of Common Stock, and if the shares are not
publicly traded, he will have the right for limited designated periods of time
to require that either the Company or the ESOP repurchase the shares. Under
these circumstances, the ESOP has the first right to repurchase the shares and,
if the ESOP declines, the Company must purchase the shares.

This right to require that either the Company or the ESOP repurchase shares
of Common Stock distributed to a terminated participant is called a "put
option," and if the participant elects to exercise the put option, the purchase
price for the shares may, at the election of the Company or the ESOP, whichever
is the purchaser, be paid with an installment note ("Note"). The ESOP currently
is obligated under six such Notes, executed in favor of terminated participants
who sold shares of Common Stock to the ESOP upon exercise of a put option. In
each case, the shares purchased by the ESOP were pledged to each respective
former participant as security for the payment of the ESOP Note and the shares
were held in an unallocated suspense account pending payment of the Note
pursuant to the terms of the ESOP. As the ESOP Trustee repays the Note each year
with contributions made to the ESOP by the Company and the subsidiaries, a
portion of the shares held in the suspense account are released and allocated to
ESOP participants in the same manner as other cash contributions are allocated.
The number of shares released each year, in general, bears the same relationship
to the total number of shares held in the suspense account as the principal
portion of the Note repaid for the year bears to the total principal balance of
the Note as of the date the payment is made. Under the terms of the Note, the
ESOP's indebtedness is nonrecourse and, except for the Common Stock pledged as
security, the only assets of the ESOP which can be used to repay the Notes are
contributions made to the ESOP by the Company and the subsidiaries, and earnings
on such contributions.

If the shares of Common Stock distributed to plan participants are publicly
traded, then the foregoing repurchase obligations will not apply, except to the
extent the shares are subject to certain trading limitations, and, for this
reason, the Company believes that the repurchase obligations will terminate upon
the consummation of this offering.

Presently, Company stock held by the ESOP is voted by the Trustee in
accordance with the directions of the Committee (as defined in the ESOP), except
when a vote concerns a corporate matter involving a merger, consolidation,
recapitalization, reclassification, liquidation, dissolution, sale of
substantially all assets of a trade or business, or other similar transactions.
In such an event, the Trustee will vote Company stock allocated to participants'
accounts in accordance with their instructions. Company stock allocated to
participants' accounts for which the Trustee does not receive voting
instructions will be voted by the Trustee, as it determines, in its sole
discretion. Following the consummation of this offering, the ESOP will be
amended to conform with Section 409(e)(2) of the Code, and ESOP participants
will be entitled to direct the Trustee as to the manner in which all shares
allocated to their respective accounts will be voted with respect to all matters
subject to shareholder vote. The Trustee will continue to vote Company stock
held in the suspense account in accordance with the directions of the Committee.

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<PAGE>
CERTAIN TRANSACTIONS

The Company completed an offering of Preferred Stock in 1994. As a result of
such offering, Conning & Company (as the direct or indirect general partner of
four investment partnerships), RFE Investment Partners IV, L.P. ("RFE") and
Saugatuck Capital Company Limited Partnership III ("Saugatuck") acquired
beneficial ownership of 25.4%, 12.0% and 12.0%, respectively, of the Common
Stock as of June 30, 1997. See "Principal and Selling Stockholders". In
connection with the Preferred Stock offering, the Company entered into the
Series A Preferred Stock Purchase Agreement (the "Preferred Stock Purchase
Agreement") with the purchasers of the Preferred Stock. Pursuant to the
Preferred Stock Purchase Agreement, among other things, (i) the four affiliates
of Conning & Company, as purchasers of Preferred Stock, were granted the right
to designate two members of the Company's Board of Directors and RFE and
Saugatuck, collectively, were granted the right to designate one member of the
Board of Directors (see "Management--Directors and Executive Officers"); (ii)
the purchasers of Preferred Stock were collectively granted the right to
designate one member to each of the Executive Compensation and Stock Option
Committee and Audit Committee of the Board of Directors; (iii) the purchasers of
the Preferred Stock were granted certain rights of first refusal with respect to
issuances of Common Stock and certain other securities by the Company; and (iv)
the purchasers of the Preferred Stock were granted certain "demand" and
"incidental" registration rights. The provisions of the Preferred Stock Purchase
Agreement relating to Board of Directors and committee membership and rights of
first refusal will terminate as a result of consummation of this offering. See
"Shares Eligible for Future Sale" for a description of the registration rights
provisions of the Preferred Stock Purchase Agreement, which will continue in
effect following consummation of this offering. The Preferred Stock is
convertible on a one-for-two basis into Common Stock at the option of the
holders and automatically upon the closing of a qualified public offering by the
Company (which includes the offering made hereby). Conning & Company and
Prudential Securities Incorporated acted as placement agents in connection with
the sale of the Preferred Stock, for which they received cash compensation of
$800,000 ($266,400 to Conning & Company), and warrants to purchase 164,706
shares of Common Stock (54,902 to Conning & Company) at an exercise price of
$8.50 per share. Conning & Company will exercise its warrants in a cashless
transaction upon consummation of the offering made hereby.

Certain affiliates of Conning & Company, RFE and Saugatuck have granted the
Underwriters an option exercisable for 30 days after the date of this Prospectus
to purchase up to an aggregate of 187,500 shares of Common Stock solely to cover
over-allotments, if any. See "Principal and Selling Stockholders" and
"Underwriting".

Since February 1995, the Company's investment portfolio manager has been
Conning Asset Management, an affiliate of Conning & Company. The Company paid
Conning Asset Management fees for services in such capacity of $119,000,
$146,000 and $81,000 in 1995, 1996 and for the six months ended June 30, 1997,
respectively. In addition, Conning & Company is acting as a representative of
the Underwriters in connection with this offering, for which it will receive
customary underwriting discounts and commissions. See "Underwriting".

The Company believes that the terms of the transactions described above are
no less favorable to the Company than terms that could have been obtained from
unaffiliated third parties.

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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS

The following table, which gives effect to the conversion of all outstanding
shares of Preferred Stock into Common Stock upon the consummation of the
offering, sets forth information as to the ownership of Common Stock as of June
30, 1997, and after giving effect to the sale of the Common Stock offered hereby
by the Company and the Selling Stockholders, by (i) each person who is known to
the Company to own beneficially more than 5% of the outstanding shares of the
Common Stock of the Company, (ii) each director, (iii) each Named Executive
Officer, (iv) executive officers and directors as a group and (v) the Selling
Stockholders.

<TABLE>
<CAPTION>
SHARES OF COMMON STOCK SHARES OF COMMON
BENEFICIALLY STOCK TO BE
OWNED PRIOR TO SHARES TO BE BENEFICIALLY OWNED
THE OFFERING (1) SOLD AFTER THE OFFERING
----------------------------- --------------- ------------------------------
<S> <C> <C> <C> <C> <C> <C>
NAME NUMBER % NUMBER % NUMBER %
- ---------------------------------------- --------------------- ----- ------- ------ --------------------- ------
NAMED EXECUTIVE OFFICERS AND DIRECTORS
Jeffrey A. Snider ...................... 461,426(2) 11.0% -- --% 461,426(2) 7.1%
300 N. Lake Ave., Ste. 300
Pasadena, CA 91101
Andrew M. Slavitt....................... 137,248(3) 3.5 -- -- 137,248(3) 2.2
James A. Nicholson...................... 182,362(4) 4.7 -- -- 182,362(4) 2.9
Bradley K Serwin........................ 60,248(5) 1.6 -- -- 60,248(5) 1.0
Victor Gloria, III...................... 105,694(6) 2.8 -- -- 105,694(6) 1.7
Jerry M. Miller......................... 17,000(7) * -- -- 17,000(7) *
Ronald W. Waisner....................... 15,000(7) * -- -- 15,000(7) *
John B. Clinton......................... 4,000(8) * -- -- 4,000(8) *
Gerard Vecchio.......................... 4,000(8) * -- -- 4,000(8) *
Owen S. Crihfield....................... 4,000(8) * -- -- 4,000(8) *
All executive officers and directors as 990,978(9) 22.0 -- -- 990,978(9) 14.5
a group (10 persons)..................
OTHER BENEFICIAL OWNERS
PAULA Financial and Subsidiaries 1,094,126 28.9 -- -- 1,094,126 17.9
Employee Stock Ownership Plan(10).....
SELLING STOCKHOLDERS
Alben F. Barkley........................ 178,032(11) 4.7 177,382 99.6 650 *
Conning & Company ...................... 996,080(12)(13)(14) 26.0 -- -- 970,855(12)(13)(14) 15.8
City Place II
185 Asylum Street
Hartford, CT 06103
Prudential Securities Incorporated...... 109,804(15) 2.8 109,804 100.0 -- --
RFE Investment Partners IV, L.P. ....... 474,588(12)(14)(16) 12.5 -- -- 474,588(12)(14)(16) 7.7
36 Grove Street
New Canaan, CT 06840
Saugatuck Capital Company Limited 474,588(12)(14)(16) 12.5 -- -- 474,588(12)(14)(16) 7.7
Partnership III ......................
One Canterbury Green
Stamford, CT 06901
</TABLE>

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

* Less than 1%

(1)Such holder directly or indirectly has sole voting and investment power with
respect to the shares listed except for shares allocated to the employee in
the ESOP pursuant to the last allocation of shares in the ESOP which was
December 31, 1996.

(2)Includes (i) options to purchase 400,000 shares of Common Stock and (ii)
1,026 shares of Common Stock allocated to Mr. Snider in the ESOP with
respect to which he currently has shared voting power, and, upon the
consummation of the offering, will have sole voting power.

67
<PAGE>
(3)Includes (i) options to purchase 134,000 shares of Common Stock and (ii) 248
shares of Common Stock allocated to Mr. Slavitt in the ESOP with respect to
which he currently has shared voting power, and, upon the consummation of
the offering, will have sole voting power.

(4)Includes (i) options to purchase 63,000 shares of Common Stock and (ii)
55,002 shares of Common Stock allocated to Mr. Nicholson in the ESOP with
respect to which he currently has shared voting power, and, upon the
consummation of the offering, will have sole voting power.

(5)Includes (i) options to purchase 57,000 shares of Common Stock, (ii) 248
shares of Common Stock allocated to Mr. Serwin in the ESOP with respect to
which he currently has shared voting power, and, upon the consummation of
the offering, will have sole voting power and (iii) 1,000 shares of Common
Stock beneficially held by Mr. Serwin which are held of record by Kenneth
Serwin, Mr. Serwin's brother.

(6)Includes (i) options to purchase 27,200 shares of Common Stock and (ii)
40,622 shares of Common Stock allocated to Mr. Gloria in the ESOP with
respect to which he currently has shared voting power, and, upon the
consummation of the offering, will have sole voting power.

(7)Includes options to purchase 15,000 shares of Common Stock.

(8)Includes options to purchase 4,000 shares of Common Stock. Mr. Crihfield's
options are held of record by Saugatuck Capital Company.

(9)Includes options to purchase 723,200 shares of Common Stock and 157,146
shares of Common Stock allocated to such executive officers and directors in
the ESOP with respect to which such holders have shared voting power, and,
upon the consummation of the offering, will have sole voting power.

(10)Pursuant to the terms of the ESOP, shares of the ESOP are voted by the
Trustee pursuant to instructions from the PAULA Financial and Subsidiaries
Employee Stock Ownership Plan Administrative Committee. Participants have
limited voting power concerning specified issues set forth in the ESOP with
respect to the shares held in the ESOP.

(11)Includes (i) 5,152 shares held as co-trustee with Rebecca H. Barkley of the
Barkley Family Trust DTD 12/14/93, (ii) 106,000 shares held as co-trustee
with Mrs. Barkley of the Barkley Charitable Remainder Unitrust DTD 12/16/96,
(iii) 66,230 shares held by Smith Barney Inc. as Trustee for the benefit of
Mr. Barkley in his individual retirement account and (iv) 650 shares held
individually. Mr. Barkley is a former Senior Vice President of Pan Am.

(12)Represents shares of Preferred Stock. Upon the consummation of the offering,
each share of Preferred Stock will convert into two shares of Common Stock.

(13)Includes warrants to purchase 54,902 shares which will be exercised without
the payment of cash upon consummation of the offering resulting in the
issuance of 29,677 shares of Common Stock to the holder. Conning Insurance
Capital Limited Partnership II is the owner of Preferred Stock convertible
into 221,176 shares of Common Stock, Conning Insurance Capital International
Partners II is the owner of Preferred Stock convertible into 249,412 shares
of Common Stock, Conning Insurance Capital Limited Partnership III is the
owner of Preferred Stock convertible into 386,542 shares of Common Stock and
Conning Insurance Capital International Partners III, L.P. is the owner of
Preferred Stock convertible into 84,048 shares of Common Stock. Each of the
foregoing entities is an affiliate of Conning & Company.

(14)Certain affiliates of Conning & Company, RFE Investment Partners IV, L.P.
and Saugatuck Capital Company Limited Partnership III have granted the
Underwriters an option exercisable for 30 days after the date of this
Prospectus to purchase up to 93,750, 46,875 and 46,875 shares of Common
Stock, respectively, solely to cover over-allotments, if any. If the
Underwriters' over-allotment option is exercised in full, shares of Common
Stock to be beneficially owned after the offering by Conning & Company, RFE
Investment Partners IV, L.P. and Saugatuck Capital Company Limited
Partnership III will be 873,162, 427,713 and 427,713, respectively.

(15)Consists of warrants to purchase 109,804 shares for $8.50 per share.

(16)Includes options to purchase 4,000 shares of Common Stock.

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<PAGE>
DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists of 15,000,000 shares of
Common Stock, $.01 par value and 5,000,000 shares of preferred stock, $.01 par
value. As of June 30, 1997, 1,900,976 shares of Common Stock were outstanding
and were held of record by 179 stockholders and 941,177 shares of Preferred
Stock were issued and outstanding and were held of record by six stockholders.
The following statements are summaries of certain provisions relating to the
Company's Common Stock and preferred stock.

COMMON STOCK

The holders of Common Stock are entitled to one vote for each share held of
record on each matter submitted to a vote of stockholders. In general, the
approval of proposals submitted to a vote of stockholders requires a favorable
vote of either the majority of the voting power of the holders of Common Stock
or the majority of the voting power of the shares represented and voting at a
duly held meeting at which a quorum is present.

Shares of Common Stock do not have cumulative voting rights with respect to
the election of directors.

Holders of Common Stock do not have any preemptive rights or rights to
subscribe for additional securities of the Company. Shares of Common Stock are
not redeemable and there are no sinking fund provisions. The shares of Common
Stock are not convertible into any other series or class of the Company's
securities.

Subject to the preferences applicable to preferred stock outstanding at the
time, holders of shares of Common Stock are entitled to dividends if, when and
as declared by the Board of Directors from funds legally available therefor, and
are entitled, in the event of liquidation, to share ratably in all assets
remaining after payment of liabilities and preferred stock preferences, if any.

PREFERRED STOCK

Upon the consummation of the offering, the Company will have no outstanding
preferred stock, but the Board of Directors of the Company, without further
action by the holders of the Common Stock, is authorized to fix the dividend
rights and terms, conversion or exchange rights, voting rights, redemption
rights and terms, liquidation preferences, sinking fund and any other
designations, powers, rights, preferences, privileges, qualifications,
limitations and restrictions applicable to each series of preferred stock. The
issuance of preferred stock could adversely affect the voting power and other
rights of the holders of Common Stock.

The authority possessed by the Board of Directors to issue preferred stock
could potentially be used to discourage attempts by others to obtain control of
the Company through a merger, tender offer, proxy contest or otherwise by making
such attempts more difficult or more costly to successfully complete. The Board
of Directors may issue preferred stock with voting, dividend or liquidation and
conversion rights that could adversely affect the rights of the holders of
Common Stock. There are no agreements or understandings for the issuance of
preferred stock, and the Board of Directors has no present intention to issue
any preferred stock.

As of June 30, 1997 the Board of Directors had designated one series of
preferred stock, comprised of 941,177 shares of the Preferred Stock, all of
which were outstanding. Each share of the Preferred Stock has a stated value of
$17.00. Upon the consummation of the offering, each share of the Preferred Stock
will, pursuant to the terms of the Series A Preferred Stock Certificate of
Designations, automatically be converted into two shares of Common Stock.

69
<PAGE>
CERTAIN CHARTER AND BYLAWS PROVISIONS

The Company's Certificate of Incorporation provides that, subject to the
rights of preferred stockholders to take action by written consent, no action
required to be taken at a meeting of the stockholders may be taken by written
consent, unless the board unanimously consents thereto.

The Company's bylaws provide that the Board be divided into three classes.
Class I Directors serve for a term ending at the first annual meeting held after
the Incorporation Date, Class II Directors serve for a term ending at the second
annual meeting held after the Incorporation Date, and Class III Directors serve
for a term ending at the third annual meeting held after the Incorporation Date.
The Company's bylaws also require stockholders to provide advance notice of any
stockholder nominations for directors and of any business to be brought before
any meeting of stockholders.

CERTAIN PROVISIONS OF DELAWARE LAW

The Company is incorporated under the Delaware General Corporation law (the
"DGCL"). The Company is subject to Section 203 of the DGCL, which, subject to
certain exceptions, restricts certain transactions and "business combinations"
between a Delaware corporation and an "interested stockholder" (defined
generally as any person who beneficially owns 15% or more of the outstanding
voting stock of the Company or any person affiliated with such person), for a
period of three years following the time that such stockholder becomes an
interested stockholder, unless (i) prior to such time the board of directors of
the corporation approved either the business combination or the transaction that
resulted in the stockholder becoming an interested stockholder; (ii) upon
consummation of the transaction that resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced (excluding for purposes of determining the number of shares
outstanding those shares owned (x) by persons who are directors and also
officers of the corporation and (y) by employee stock plans in which employee
participants do not have the right to determine confidentially whether shares
held subject to the plan will be tendered in a tender or exchange offer); or
(iii) at or subsequent to such time the business combination is approved by the
board of directors of the corporation and authorized at a meeting of the
stockholders (and not by written consent) by the affirmative vote of at least
66 2/3% of the outstanding voting stock of the corporation that is not owned by
the interested stockholder.

Section 203 and the provisions of the Company's Certificate of Incorporation
and Bylaws described above may make it more difficult for a third party to
acquire, or discourage acquisition bids for, the Company. Section 203 and these
provisions could have the effect of inhibiting attempts to change the membership
of the Company's Board of Directors.

TRANSFER AGENT

The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services, L.L.C.

QUOTATION

The Common Stock will be quoted on the Nasdaq National Market under the
symbol "PFCO".

INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 102 of the DGCL authorizes a Delaware corporation to include a
provision in its certificate of incorporation limiting or eliminating the
personal liability of its directors to the corporation and its stockholders for
monetary damages for breach of the directors' fiduciary duty of care. The duty
of care requires that, when acting on behalf of the corporation, directors
exercise an informed business judgment based on all material information
reasonably available to them. Absent the limitations authorized

70
<PAGE>
by such provision, directors are accountable to corporations and their
stockholders for monetary damages for conduct constituting gross negligence in
the exercise of their duty of care. Although Section 102 of the DGCL does not
change a director's duty of care, it enables corporations to limit available
relief to equitable remedies such as injunction or rescission. The Company's
Certificate of Incorporation and Bylaws include provisions which limit or
eliminate the personal liability of its directors to the fullest extent
permitted by Section 102 of the DGCL. Consequently, a director or officer will
not be personally liable to the Company or its stockholders for monetary damages
for breach of fiduciary duty as a director, except for (i) any breach of the
director's duty of loyalty to the Company or its stockholders, (ii) acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) unlawful payments of dividends or unlawful stock
repurchases, redemptions or other distributions and (iv) any transaction from
which the director derived an improper personal benefit.

The Company's Certificate of Incorporation and Bylaws also provide, in
effect, that, to the fullest extent and under the circumstances permitted by
Section 145 of the DGCL, the Company will indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative, by reason of the fact that he or she is a director or officer of
the Company, or is or was serving at the request of the Company as a director or
officer of another corporation or enterprise. The inclusion of these
indemnification provisions in the Company's Certificate of Incorporation and
Bylaws is intended to enable the Company to attract qualified persons to serve
as directors and officers who might otherwise be reluctant to do so. The Company
may, in its discretion, similarly indemnify its employees and agents.

Depending upon the character of the proceeding, the Company may indemnify
its directors and officers against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
in connection with any action, suit or proceeding if the person indemnified
acted in good faith and in a manner he or she reasonably believed to be in or
not opposed to the best interests of the Company, and, with respect to any
criminal action or proceeding, had no cause to believe his or her conduct was
unlawful. To the extent that a director or officer of the Company has been
successful in the defense of any action, suit or proceeding referred to above,
under the DGCL, the Company would have the obligation to indemnify him or her
against expenses (including attorneys' fees) actually and reasonably incurred in
connection therewith.

In addition, the limited liability provisions in the Certificate of
Incorporation and the indemnification provisions in the Certificate of
Incorporation and Bylaws may discourage stockholders from bringing a lawsuit
against directors for breach of their fiduciary duty (including breaches
resulting from grossly negligent conduct) and may have the effect of reducing
the likelihood of derivative litigation against directors and officers, even
though such an action, if successful, might otherwise have benefited the Company
and its stockholders. Furthermore, a stockholder's investment in the Company may
be adversely affected to the extent the Company pays the costs of settlement and
damage awards against directors and officers of the Company pursuant to the
indemnification provisions in the Company's Bylaws. The limited liability
provisions in the Certificate of Incorporation will not limit the liability of
directors under federal securities laws.

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, the Company will have outstanding
6,135,625 shares of Common Stock (after giving effect to the conversion of the
Preferred Stock into Common Stock and exercise of outstanding warrants for
Common Stock upon the closing of this offering), 3,635,625 shares of which will
be "restricted securities" for purposes of Rule 144 promulgated under the
Securities Act. In addition, the Company intends to file a registration
statement under the Securities Act within 90 days of the date of this Prospectus
to register 750,000 shares of Common Stock reserved for issuance pursuant to the
Plans, and an additional 376,000 shares issuable upon exercise of options issued
outside of the Plans. Shares issued upon exercise of outstanding options and
distributed to participants of the ESOP after the

71
<PAGE>
effective date of such registration statement generally may be sold on the open
market without restriction. See "Management--Stock Incentive Plans".

In general, under Rule 144, as currently in effect, a person (or persons
whose shares are required to be aggregated), including affiliates of the
Company, who has beneficially owned "restricted securities" for at least one
year may sell within any three-month period a number of such shares that does
not exceed the greater of (i) one percent of the total number of outstanding
shares of Common Stock or (ii) the reported average weekly trading volume of the
Common Stock on the Nasdaq National Market during the four calendar weeks
preceding the date on which notice of the sale is filed with the Commission.
Sales under Rule 144 are also subject to certain manner-of-sale provisions or
notice requirements and the availability of current public information about the
Company. A person who is not deemed to have been an "affiliate" of the Company
at any time during the 90 days preceding a sale, and who has beneficially owned
"restricted securities" for at least two years, may sell such shares under Rule
144(k) without regard to the volume limitations, manner-of-sale provisions or
notice requirements. Sales of "restricted securities" by affiliates, even after
a two-year holding period, must continue to be made in brokers' transactions
subject to the volume limitations described above. As defined in Rule 144, an
"affiliate" of an issuer is a person that directly, or indirectly through one or
more intermediaries, controls, or is controlled by, or is under common control
with, such issuer. The above summary of Rule 144 is not intended to be a
complete description of that rule. Substantially all of the shares of Common
Stock outstanding prior to this offering are eligible for sale under Rule 144,
subject to lock-up arrangements with the Underwriters described below, and
958,530 shares which are held by the ESOP may be eligible for resale without
compliance with Rule 144 upon the distribution of such shares to participants in
the ESOP upon termination of employment.

Pursuant to the Preferred Stock Purchase Agreement, the purchasers of the
Preferred Stock were entitled to certain rights with respect to the registration
under the Securities Act of shares of Common Stock issuable upon conversion of
the Preferred Stock and other shares of capital stock acquired by such
purchasers (collectively, the "Registrable Securities"). The Preferred Stock
Purchase Agreement provides that holders of at least 51% of the Registrable
Securities may request that the Company file a registration statement under the
Securities Act with respect to any of the Registrable Securities and, upon such
request, the Company is required to use its best efforts to effect such
registration. The Company is not required to effect more than two such
registrations. In addition, subject to certain exceptions and limitations, if
the Company's proposes to register any of its securities, the Company is
required to notify the holders of Registrable Securities and to include in such
registration some or all of the Registrable Securities which such holders may
request. Shares of Common Stock registered pursuant to the exercise of such
registration rights will be freely salable without restriction.

The Company, its executive officers and directors, the ESOP and certain
other holders (including the holders of all of the Registrable Securities) of
Common Stock, which in the aggregate will hold approximately 48.5% of the Common
Stock outstanding after the offering, have agreed that, during the period
beginning from the date of this Prospectus and continuing to and including the
date 180 days after the date of this Prospectus, they will not offer, sell,
contract to sell or otherwise dispose of, or, with certain exceptions, file or
cause to be filed with the Commission a registration statement with respect to,
shares of Common Stock (other than, in the case of the Company, pursuant to
employee stock option plans existing, or on the conversion or exchange of
convertible or exchangeable securities outstanding, on the date of this
Prospectus and, in the case of the ESOP, distributions of shares to participants
in the ESOP upon termination of such participants' employment with the Company)
or any securities of the Company which are substantially similar to the shares
of Common Stock or which are convertible into or exchangeable for shares of
Common Stock or securities which are substantially similar to the shares of
Common Stock without the prior written consent of the representatives of the
Underwriters, except for the shares of Common Stock offered in connection with
the offering.

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Prior to this offering, there has been no public market for the Common
Stock. No prediction can be made as to the effect, if any, that future sales of
shares pursuant to a future registration statement or Rule 144 or the
availability of shares for future sale will have on the market price of the
Common Stock prevailing from time to time. Sales of substantial amounts of the
Common Stock in the public market or the prospect of such sales could adversely
affect prevailing market prices.

VALIDITY OF COMMON STOCK

The validity of the Common Stock offered hereby will be passed upon for the
Company by Gibson, Dunn & Crutcher LLP, Los Angeles, California, and for the
Underwriters by Sullivan & Cromwell, Los Angeles, California.

EXPERTS

The consolidated financial statements and schedules of the Company as of
December 31, 1995 and 1996 and June 30, 1997, and for each of the years in the
three-year period ended December 31, 1996 and the six month period ended June
30, 1997, included herein and elsewhere in the Registration Statement have been
included herein and in the Registration Statement in reliance upon the report of
KPMG Peat Marwick LLP, independent certified public accountants, appearing
elsewhere herein and upon the authority of such firm as experts in accounting
and auditing.

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Independent Auditors' Report.............................................................................. F-2

Consolidated Balance Sheets as of December 31, 1995 and 1996 and June 30, 1997............................ F-3

Consolidated Statements of Income for each of the three years in the period ended December 31, 1996 and
the six months ended June 30, 1996 (unaudited) and 1997................................................. F-5

Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December
31, 1996 and the six months ended June 30, 1996 (unaudited) and 1997.................................... F-6

Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1996
and the six months ended June 30, 1996 (unaudited) and 1997............................................. F-7

Notes to Consolidated Financial Statements as of December 31, 1995 and 1996 and June 30, 1997............. F-8
</TABLE>

F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT

The Board of Directors

PAULA Financial:

We have audited the accompanying consolidated balance sheets of PAULA
Financial and subsidiaries as of December 31, 1995 and 1996 and June 30, 1997
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1996 and
the six-month period ended June 30, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PAULA
Financial and subsidiaries as of December 31, 1995 and 1996 and June 30, 1997
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1996 and the six-month period ended
June 30, 1997 in conformity with generally accepted accounting principles.

Also, in our opinion, the information set forth under the captions "Income
Statement Data" and "Balance Sheet Data" in the selected consolidated financial
data as of December 31, 1995 and 1996 and June 30, 1997 and for each of the
years in the three-year period ended December 31, 1996 and the six-month period
ended June 30, 1997, appearing on pages 20 and 21, is fairly stated, in all
material respects, in relation to the consolidated financial statements from
which it has been derived.

/s/ KPMG Peat Marwick LLP

Los Angeles, California

August 25, 1997, except as to
Note 13 which is as of
September 30, 1997

F-2
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

ASSETS

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- JUNE 30,
1995 1996 1997
----------- --------- --------- PRO FORMA
JUNE 30,
1997
------------
(UNAUDITED)
(SEE NOTE 8)
<S> <C> <C> <C> <C>
Investments:
Fixed maturities, available for sale, at market (amortized
cost $78,694, $80,252 and $85,485 at December 31, 1995 and
1996 and June 30, 1997, respectively)...................... $ 81,053 81,371 86,605 86,605
Preferred stock, at market (cost $1,014 and $2,007 at
December 31, 1996 and June 30, 1997, respectively)......... -- 1,033 2,045 2,045
Common stock, at market (cost $734 at December 31, 1995 and
1996 and $734 at June 30, 1997)............................ 690 777 884 884
Invested cash, at cost (approximates market)................. 2,248 3,611 3,845 3,845
----------- --------- --------- ------------
Total investments........................................ 83,991 86,792 93,379 93,379
----------- --------- --------- ------------
Cash, unrestricted............................................. 1,294 6,264 4,734 4,734
Cash, restricted............................................... 3,117 832 1,908 1,908
Accrued investment income...................................... 1,559 1,483 1,492 1,492

Receivables:
Accounts receivable, net of allowance for uncollectible
accounts ($358, $500 and $525 at December 31, 1995 and 1996
and June 30, 1997, respectively)........................... 5,369 6,274 11,775 11,775
Unbilled premiums............................................ 5,234 5,279 7,750 7,750
Reinsurance recoverable on paid losses and loss adjustment
expenses................................................... 144 172 61 61
Reinsurance recoverable on unpaid losses and loss adjustment
expenses................................................... 6,775 6,427 6,437 6,437
Income taxes recoverable..................................... 2,051 432 2,011 2,011
Other........................................................ 197 317 353 353
----------- --------- --------- ------------
Total receivables........................................ 19,770 18,901 28,387 28,387
----------- --------- --------- ------------
Property and equipment, at cost:
Office furniture, fixtures and equipment..................... 5,989 6,668 7,065 7,065
Automobiles.................................................. 636 590 590 590
Leasehold improvements....................................... 203 211 220 220
----------- --------- --------- ------------
6,828 7,469 7,875 7,875
Less accumulated depreciation................................ (4,541) (5,403) (5,654) (5,654)
----------- --------- --------- ------------
Net property and equipment............................... 2,287 2,066 2,221 2,221
----------- --------- --------- ------------
Other assets................................................... 529 2,077 4,118 4,118
Excess of cost over net assets acquired, net................... 2,198 1,883 1,652 1,652
Deferred income taxes.......................................... 4,161 4,829 4,029 4,029
----------- --------- --------- ------------
$ 118,906 125,127 141,920 141,920
----------- --------- --------- ------------
----------- --------- --------- ------------
</TABLE>

(Continued)

F-3
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS, CONTINUED

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- JUNE 30,
1995 1996 1997
----------- --------- --------- PRO FORMA
JUNE 30,
1997
------------
(UNAUDITED)
(SEE NOTE 8)
<S> <C> <C> <C> <C>
Unpaid losses and loss adjustment expenses..................... $ 57,049 55,720 64,972 64,972
Unearned premiums.............................................. 4,609 10,655 13,364 13,364
Accrued policyholder dividends................................. 5,008 3,981 3,586 3,586
Due to underwriters and assureds............................... 4,938 2,176 3,605 3,605
Accounts payable and accrued expenses.......................... 2,673 3,891 5,112 5,112
Notes payable.................................................. 5,302 3,789 2,107 2,107
Note payable to bank........................................... 5,522 7,490 9,361 9,361
Obligation on stock held by ESOP............................... 8,200 11,449 11,495 11,495
----------- --------- --------- ------------
93,301 99,151 113,602 113,602
----------- --------- --------- ------------
Series A Preferred Stock, convertible and redeemable (see Note
8), $0.01 par value. Authorized 5,000,000 shares; issued
941,177 shares at December 31, 1995 and 1996 and June 30,
1997.......................................................... 19,501 21,402 22,776 --

Stockholders' equity:
Common stock, $0.01 par value. Authorized 15,000,000 shares;
issued 2,266,390 shares, 2,167,456 shares and 2,033,074
shares at December 31, 1995 and 1996 and June 30, 1997,
respectively............................................... 22 22 20 39
Additional paid-in capital................................... 1,414 1,748 1,724 24,481
Retained earnings............................................ 16,117 16,668 16,113 16,113
Net unrealized gain on investments........................... 1,528 778 862 862
----------- --------- --------- ------------
19,081 19,216 18,719 41,495
Less:
Treasury stock, at cost (396,294 shares, 264,196 shares and
132,098 shares at December 31, 1995 and 1996 and June 30,
1997, respectively)...................................... (4,458) (2,972) (1,486) (1,486)
Obligation on stock held by ESOP........................... (8,200) (11,449) (11,495) (11,495)
Guarantee of notes payable of ESOP......................... (319) (221) (196) (196)
----------- --------- --------- ------------
Net stockholders' equity................................. 6,104 4,574 5,542 28,318

Commitments and contingencies
----------- --------- --------- ------------
$ 118,906 125,127 141,920 141,920
----------- --------- --------- ------------
----------- --------- --------- ------------
</TABLE>

See accompanying notes to consolidated financial statements.

F-4
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEARS ENDED DECEMBER 31, 30,
------------------------------------- ------------------------
1994 1995 1996 1996 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Income:
Premiums earned:
Workers' compensation................... $ 50,977 44,224 54,563 21,751 41,303
Group medical and life.................. 312 307 941 471 475
Commissions............................... 4,299 3,964 4,213 2,061 1,716
Net investment income..................... 4,536 4,817 4,701 2,322 2,499
Net realized investment gains............. -- 37 444 427 --
Other..................................... 1,712 1,569 896 514 347
----------- ----------- ----------- ----------- -----------
61,836 54,918 65,758 27,546 46,340
----------- ----------- ----------- ----------- -----------

Expenses:
Losses and loss adjustment expenses
incurred................................ 28,618 29,363 33,900 13,937 28,447
Dividends provided for policyholders...... 6,221 3,438 1,628 620 309
Operating................................. 20,720 22,608 25,480 10,484 14,752
----------- ----------- ----------- ----------- -----------
55,559 55,409 61,008 25,041 43,508
----------- ----------- ----------- ----------- -----------

Income (loss) before income tax
expense (benefit)......................... 6,277 (491) 4,750 2,505 2,832

Income tax expense (benefit)................ 1,572 (791) 827 443 538
----------- ----------- ----------- ----------- -----------
Net income.......................... $ 4,705 300 3,923 2,062 2,294
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------

Earnings per share.......................... $ 1.16 0.08 0.95 0.51 0.56

Weighted average shares outstanding......... 4,052,992 3,988,649 4,123,352 4,047,965 4,120,020
</TABLE>

See accompanying notes to consolidated financial statements.

F-5
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK
------------------------ ADDITIONAL
NUMBER OF PAID IN RETAINED
SHARES BOOK VALUE CAPITAL EARNINGS
----------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1993...................................... 3,530,838 $ 36 265 28,175
Net income........................................................ 4,705
Change in carrying value of preferred stock....................... (4,013)
Retirement of common stock........................................ (1,245,294) (12) (86)
Issuance of common stock.......................................... 60,000 510 (10,486)
Cumulative effect of change in accounting, net of taxes...........
Net change in unrealized gain on investments (net of tax).........
Change in obligation of stock held by ESOP........................
Change in guarantee of notes payable of ESOP......................
----------- --- ----- -----------
Balance at December 31, 1994...................................... 2,345,544 24 689 18,381
----------- --- ----- -----------
Net income........................................................ 300
Change in carrying value of preferred stock....................... (583)
Restricted stock grants........................................... 28,700 259
Restricted stock forfeitures...................................... (9,500) (86)
Retirement of common stock........................................ (169,816) (2) (12) (1,981)
Issuance of common stock.......................................... 71,462 564
Net change in unrealized gain on investments (net of tax).........
Repurchase of common stock........................................
Change in obligation of stock held by ESOP........................
Change in guarantee of notes payable of ESOP......................
----------- --- ----- -----------
Balance at December 31, 1995...................................... 2,266,390 22 1,414 16,117
----------- --- ----- -----------
Net income........................................................ 3,923
Change in carrying value of preferred stock....................... (1,901)
Restricted stock grants........................................... 22,500 177
Restricted stock forfeitures...................................... (1,400) (12)
Retirement of common stock........................................ (132,098) (10) (1,471)
Issuance of common stock.......................................... 12,064 179
Net change in unrealized gain on investments (net of tax).........
Change in obligation of stock held by ESOP........................
Change in guarantee of notes payable of ESOP......................
----------- --- ----- -----------
Balance at December 31, 1996...................................... 2,167,456 22 1,748 16,668
----------- --- ----- -----------
Net income........................................................ 2,294
Change in carrying value of preferred stock....................... (1,374)
Restricted stock forfeitures...................................... (200) (2)
Retirement of common stock........................................ (135,438) (2) (36)
Issuance of common stock.......................................... 1,256 14
Retirement of common stock........................................ (1,475)
Net change in unrealized gain on investments (net of tax).........
Retirement of common stock........................................
Change in obligation of stock held by ESOP........................
Change in guarantee of notes payable of ESOP......................
----------- --- ----- -----------
Balance at June 30, 1997.......................................... 2,033,074 $ 20 1,724 16,113
----------- --- ----- -----------
----------- --- ----- -----------

NET UNREALIZED OBLIGATION ON
GAIN (LOSS) ON TREASURY STOCK HELD BY
INVESTMENTS STOCK ESOP
----------------- ----------- ---------------
<S> <C> <C>
Balance at December 31, 1993...................................... 47 (15,026)
Net income........................................................
Change in carrying value of preferred stock.......................
Retirement of common stock........................................
Issuance of common stock..........................................
Cumulative effect of change in accounting, net of taxes........... 931
Net change in unrealized gain on investments (net of tax)......... (1,599)
Change in obligation of stock held by ESOP........................
Change in guarantee of notes payable of ESOP...................... 4,989
------ ----------- -------
Balance at December 31, 1994...................................... (621) -- (10,037)
------ ----------- -------
Net income........................................................
Change in carrying value of preferred stock.......................
Restricted stock grants...........................................
Restricted stock forfeitures......................................
Retirement of common stock........................................
Issuance of common stock..........................................
Net change in unrealized gain on investments (net of tax)......... 2,149
Repurchase of common stock........................................ (4,458)
Change in obligation of stock held by ESOP........................ 1,837
Change in guarantee of notes payable of ESOP......................
------ ----------- -------
Balance at December 31, 1995...................................... 1,528 (4,458) (8,200)
------ ----------- -------
Net income........................................................
Change in carrying value of preferred stock.......................
Restricted stock grants...........................................
Restricted stock forfeitures......................................
Retirement of common stock........................................ 1,486
Issuance of common stock..........................................
Net change in unrealized gain on investments (net of tax)......... (750)
Change in obligation of stock held by ESOP........................ (3,249)
Change in guarantee of notes payable of ESOP......................
------ ----------- -------
Balance at December 31, 1996...................................... 778 (2,972) (11,449)
------ ----------- -------
Net income........................................................
Change in carrying value of preferred stock.......................
Restricted stock forfeitures......................................
Retirement of common stock........................................
Issuance of common stock..........................................
Retirement of common stock........................................
Net change in unrealized gain on investments (net of tax)......... 84
Retirement of common stock........................................ 1,486
Change in obligation of stock held by ESOP........................ (46)
Change in guarantee of notes payable of ESOP......................
------ ----------- -------
Balance at June 30, 1997.......................................... 862 (1,486) (11,495)
------ ----------- -------
------ ----------- -------

GUARANTEE OF NET
NOTES PAYABLE OF STOCKHOLDERS'
ESOP EQUITY
----------------- ---------------
Balance at December 31, 1993...................................... (392) 13,105
Net income........................................................ 4,705
Change in carrying value of preferred stock....................... (4,013)
Retirement of common stock........................................ (98)
Issuance of common stock.......................................... (9,976)
Cumulative effect of change in accounting, net of taxes........... 931
Net change in unrealized gain on investments (net of tax)......... (1,599)
Change in obligation of stock held by ESOP........................ (49) (49)
Change in guarantee of notes payable of ESOP...................... 4,989
--- -------
Balance at December 31, 1994...................................... (441) 7,995
--- -------
Net income........................................................ 300
Change in carrying value of preferred stock....................... (583)
Restricted stock grants........................................... 259
Restricted stock forfeitures...................................... (86)
Retirement of common stock........................................ (1,995)
Issuance of common stock.......................................... 564
Net change in unrealized gain on investments (net of tax)......... 2,149
Repurchase of common stock........................................ (4,458)
Change in obligation of stock held by ESOP........................ 1,837
Change in guarantee of notes payable of ESOP...................... 122 122
--- -------
Balance at December 31, 1995...................................... (319) 6,104
--- -------
Net income........................................................ 3,923
Change in carrying value of preferred stock....................... (1,901)
Restricted stock grants........................................... 177
Restricted stock forfeitures...................................... (12)
Retirement of common stock........................................ 5
Issuance of common stock.......................................... 179
Net change in unrealized gain on investments (net of tax)......... (750)
Change in obligation of stock held by ESOP........................ (3,249)
Change in guarantee of notes payable of ESOP...................... 98 98
--- -------
Balance at December 31, 1996...................................... (221) 4,574
--- -------
Net income........................................................ 2,294
Change in carrying value of preferred stock....................... (1,374)
Restricted stock forfeitures...................................... (2)
Retirement of common stock........................................ (38)
Issuance of common stock.......................................... 14
Retirement of common stock........................................ (1,475)
Net change in unrealized gain on investments (net of tax)......... 84
Retirement of common stock........................................ 1,486
Change in obligation of stock held by ESOP........................ (46)
Change in guarantee of notes payable of ESOP...................... 25 25
--- -------
Balance at June 30, 1997.......................................... (196) 5,542
--- -------
--- -------
</TABLE>

See accompanying notes to consolidated financial statements.

F-6
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- ----------------------------
1994 1995 1996 1997
--------- --------- --------- 1996 -------------
-------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income.............................................. $ 4,705 300 3,923 2,062 2,294
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization......................... 981 1,357 1,509 703 621
Amortization of fixed maturity premium, net........... 1,322 965 797 436 326
(Gain) loss on sale of property and equipment......... 48 37 (12) 6 13
Gain on sales and calls of equity and fixed
maturities.......................................... -- (37) (444) (427) --
(Increase) decrease in receivables.................... (2,986) (3,888) 946 (1,493) (9,495)
(Increase) decrease in deferred taxes................. (439) 799 (282) (35) 757
Increase (decrease) in unpaid losses and loss
adjustment expenses................................. (2,156) (3,424) (1,328) (1,452) 9,252
Increase (decrease) in accrued policyholder
dividends........................................... (297) 69 (1,027) (425) (395)
Increase (decrease) in accounts payable and accrued
expenses............................................ 948 1,095 (1,544) (1,628) 2,649
Increase in unearned premiums......................... 251 395 6,046 4,600 2,709
Other, net............................................ 181 72 80 (175) (637)
--------- --------- --------- ------------- -------------
Net cash provided by (used in) operating
activities...................................... 2,558 (2,260) 8,664 2,172 8,094
--------- --------- --------- ------------- -------------
Cash flows from investing activities:
Proceeds from sale of common stock...................... 586 -- -- -- --
Proceeds from sale of available for sale fixed
maturities............................................ 1,591 22,615 17,236 12,547 --
Proceeds from maturities and calls of available for sale
fixed maturities...................................... 4,500 454 7,930 800 4,494
Proceeds from maturities and calls of held to maturity
fixed maturities...................................... 4,740 -- -- -- --
Proceeds from sale of property and equipment............ 176 139 146 65 (29)
Purchase of available for sale common stock............. (479) -- -- -- --
Purchase of available for sale preferred stock.......... -- -- (1,014) -- (2,183)
Purchase of available for sale fixed maturities......... (7,841) (21,700) (26,456) (14,169) (10,152)
Purchase of held to maturity fixed maturities........... (6,103) -- -- -- --
Purchase of property and equipment...................... (1,172) (1,138) (1,029) (252) (588)
Purchase of other assets................................ -- -- (703) -- --
Purchase of insurance agency............................ (1,691) (65) (38) (100) (20)
--------- --------- --------- ------------- -------------
Net cash provided by (used in) investing
activities...................................... (5,693) 305 (3,928) (1,109) (8,478)
--------- --------- --------- ------------- -------------
Cash flows from financing activities:
Borrowings under line of credit agreement, net.......... 150 3,122 1,968 2,118 1,871
Payments on notes payable............................... (289) (1,054) (1,782) (1,630) (1,682)
Issuance of notes payable............................... 926 214 269 -- --
Proceeds from sale of preferred stock................... 14,905 -- -- -- --
Sale of common stock.................................... 510 4 343 -- 14
Retirement of common stock.............................. (10,585) (1,994) (1,486) (10) (39)
--------- --------- --------- ------------- -------------
Net cash provided by (used in) financing
activities...................................... 5,617 292 (688) 478 164
--------- --------- --------- ------------- -------------
Net increase (decrease) in cash and invested
cash............................................ 2,482 (1,663) 4,048 1,541 (220)
Cash and invested cash at beginning of period............. 5,840 8,322 6,659 6,659 10,707
--------- --------- --------- ------------- -------------
Cash and invested cash at end of period................... $ 8,322 6,659 10,707 8,200 10,487
--------- --------- --------- ------------- -------------
--------- --------- --------- ------------- -------------
Supplemental schedule of noncash financing activities:
In 1995, the Company purchased common stock from the retiring chairman through the issuance of a note payable in the
amount of $4,458 (see note 8).
In 1995, the Company granted to employees 28,700 shares of restricted common stock for a total value of $259. Also in
1995, 9,500 shares were forfeited at a value of $86 (see note 9).
In November 1995, the Company acquired Desert Benefits, Inc. for a total purchase price of $700. Common stock was
issued to settle $560 of the purchase price (see note 12).
In 1996, the Company granted to employees 22,500 shares of restricted common stock for a total value of $177. Also in
1996, 1,400 shares were forfeited at a value of $12 (see note 9).
In 1996, the Company purchased Guinn Sinclair Insurance Services for a total purchase price of $221. Common stock was
issued to settle $176 of the purchase price (see note 12).
</TABLE>

See accompanying notes to consolidated financial statements.

F-7
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1996 AND JUNE 30, 1997
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF OPERATIONS

PAULA Financial and subsidiaries (collectively referred to as the Company)
is an integrated insurance organization specializing in the production,
underwriting and servicing of workers' compensation and accident and health
insurance for agribusiness clients in California, Arizona, Oregon, Idaho,
Alaska, Texas and Florida. For the year ended December 31, 1996, 66% of premiums
earned were generated in California, and Arizona accounted for 22% of premiums
earned. For the six months ended June 30, 1997, California, Arizona and Oregon
accounted for 69%, 15% and 12%, respectively, of premiums earned. The Company
operates from many offices located throughout prime agricultural areas and
places coverage with its insurance company subsidiaries and nonaffiliated
insurance companies. The Company has recently obtained a license in the state of
New Mexico.

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of
PAULA Financial and its wholly owned subsidiaries. The principal subsidiaries
are: Pan American Underwriters, Inc., Pan American Underwriters Insurance Agents
and Brokers, Inc., Agri-Comp Insurance Agency, Inc. and PAULA Trading Company
Insurance Agents and Brokers, Inc. (insurance brokerages); Pan Pacific Benefit
Administrators, Inc. (third-party administration operation); PAULA Mexico S.A.
de C.V.; PAULA Insurance Company (casualty insurance); and PAULA Assurance
Company (group accident and health and life insurance).

All significant intercompany balances and transactions have been eliminated
in consolidation.

In preparing the consolidated financial statements, management is required
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities as of the
date of the consolidated financial statements and revenues and expenses for the
period. Actual results could differ significantly from those estimates.

The unaudited consolidated financial statements as of and for the six months
ended June 30, 1996 include, in the opinion of management, all adjustments
(consisting only of normal recurring accruals) necessary for a fair presentation
of the information for such periods.

The results of operations for the six months ended June 30, 1997 are not
necessarily indicative of the results to be expected for the full year.

INVESTMENTS AND CASH

At December 31, 1995 and 1996 and June 30, 1997, the entire investment
portfolio is classified as available-for-sale and is reflected at estimated fair
value with unrealized gains and losses recorded as a separate component of
stockholders' equity, net of related deferred income taxes. The premium and
discount on fixed maturities and collateralized mortgage obligations are
amortized using the scientific method. Amortization and accretion of premiums
and discounts on collateralized mortgage obligations are adjusted for principal
paydowns and changes in expected maturities. Investments in which the decline in
market value is deemed other than temporary are reduced to the estimated
realizable value through a charge to income.

F-8
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
On January 1, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" (SFAS 115). At adoption, the Company's portfolio was
divided between the held to maturity and available-for-sale classifications. The
impact of adoption of SFAS 115 was a net unrealized gain on investments of $931
in January 1994, net of taxes of $479.

On November 21, 1995, the Company transferred its entire held-to-maturity
portfolio to available-for-sale. The amortized cost at the transfer date was
$37,508. The transfer resulted in an unrealized gain of $396, net of the tax
impact. The transfer was made in accordance with implementation guidance
provided in the Financial Accounting Standards Board's Special Report, "A Guide
to Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities."

Invested cash consists primarily of commercial paper.

Realized gains and losses on sales of investments are computed on the
specific-identification basis.

Restricted cash consists of premiums collected by the insurance brokerage
subsidiaries but not yet remitted to insurance companies which is restricted as
to use by law in the states in which the brokerage subsidiaries operate.

For purposes of cash flow disclosure, cash and invested cash is defined as
cash and invested cash that have original maturities of less than three months.

REVENUE RECOGNITION

Premiums are earned by the insurance subsidiaries on a monthly pro rata
basis over the terms of the policies. Commission income is recorded on the
effective date of the policy or the billing date, whichever is later.

PROPERTY AND EQUIPMENT

Depreciation and amortization is provided over the estimated useful lives of
the respective assets, primarily using the modified accelerated cost recovery
system (which approximates the double-declining-balance method). Principal
estimated useful lives used in computing the depreciation provisions are five
years for automobiles and five to seven years for furniture and equipment.

Leasehold improvements are depreciated on a straight-line basis over the
term of the lease or the estimated useful life of the improvement if less than
the lease term.

EXCESS OF COST OVER NET ASSETS ACQUIRED

Excess of cost over net assets acquired is amortized on a straight-line
basis over seven years. The Company assesses the recoverability of this
intangible asset by determining whether the amortization of the balance over its
remaining life can be recovered through the undiscounted future operating cash
flows of the acquired operation. Accumulated amortization totaled $397, $766 and
$957 at December 31, 1995 and 1996, and June 30, 1997, respectively.

F-9
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

The liability for unpaid losses and loss adjustment expenses represents (a)
case basis estimates of reported losses and loss adjustment expenses and (b)
estimates based on past experience of unreported losses and loss adjustment
expenses, net of anticipated salvage and subrogation. Management believes that
the provisions for losses and loss adjustment expenses are adequate to cover the
net cost of incurred losses and loss adjustment expenses; however, the liability
is by necessity based on estimates, and accordingly, there can be no assurance
that the ultimate liability will not differ from such estimates.

There is a high level of uncertainty inherent in the evaluation of the
liability for unpaid losses and loss adjustment expenses. The ultimate costs of
such claims are dependent upon future events, the outcomes of which are affected
by many factors. Loss reserving procedures and settlement philosophy, current
and perceived social and economic factors, inflation, current and future court
rulings and jury attitudes, and many other economic, scientific, legal,
political and social factors can all have significant effects on the ultimate
costs of claims. Changes in Company operations and management philosophy may
also cause actual developments to vary from the past.

POLICYHOLDER DIVIDENDS

The insurance subsidiaries underwrite workers' compensation, accident and
health and life insurance policies. Participating workers' compensation policies
represented approximately 81%, 89%, 84% and 85% of net written premium for the
years ended December 31, 1994, 1995 and 1996, and the six months ended June 30,
1997, respectively. Dividends are recorded as a liability based on estimates of
ultimate amounts expected to be declared by the insurance subsidiaries' Boards
of Directors, at their discretion.

INCOME TAXES

The Company accounts for income taxes under the asset and liability method.
Accordingly, deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair values of financial instruments are estimates of the fair values at
a specific point in time using appropriate valuation methodologies. These
estimates are subjective in nature and involve uncertainties and significant
judgment in the interpretation of current market data. Therefore, the fair
values presented are not necessarily indicative of amounts the Company could
realize or settle currently. The Company does not necessarily intend to dispose
of or liquidate such instruments prior to maturity.

The fair values of notes payable and note payable to bank are estimated
using discounted cash flow analyses based on current market interest rates. The
estimated fair values approximate the related carrying values.

F-10
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
EARNINGS PER SHARE (EPS)

The EPS calculations for the years ended December 31, 1994, 1995 and 1996
and the six months ended June 30, 1996 and 1997 were based upon the weighted
average number of shares of common stock outstanding adjusted for the effect of
convertible securities, options and warrants considered to be common stock
equivalents and options issued since August 1996 pursuant to Staff Accounting
Bulletin No. 83. Stock options and warrants are considered to be common stock
equivalents, except when their effect is antidilutive.

SUPPLEMENTAL INFORMATION

The June 30, 1996 information presented in these consolidated financial
statements is for an unaudited interim period which is presented for comparative
purposes only.

(2) INVESTMENTS

Investments in fixed maturities are all held in investment grade securities.
Fair values were obtained from published securities quotation services.

F-11
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(2) INVESTMENTS (Continued)
FIXED MATURITIES

The amortized cost and estimated fair value of investments in fixed
maturities classified as available for sale at December 31, 1995 and 1996 and
June 30, 1997 are as follows:

<TABLE>
<CAPTION>
DECEMBER 31, 1995
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of U.S. Government
corporations and agencies..................................... $ 20,248 588 (11) 20,825
Obligations of states and political subdivisions................ 50,366 1,254 (1) 51,619
Corporate securities............................................ 8,080 529 -- 8,609
----------- ----- --- -----------
Total....................................................... $ 78,694 2,371 (12) 81,053
----------- ----- --- -----------
----------- ----- --- -----------
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1996
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of U.S. Government
corporations and agencies..................................... $ 16,619 207 (27) 16,799
Obligations of states and political subdivisions................ 47,238 798 (28) 48,008
Corporate securities............................................ 9,370 193 (3) 9,560
Collateralized mortgage obligations............................. 7,025 2 (23) 7,004
----------- ----- --- -----------
Total....................................................... $ 80,252 1,200 (81) 81,371
----------- ----- --- -----------
----------- ----- --- -----------
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1997
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
----------- ----------- --------------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of U.S. Government
corporations and agencies..................................... $ 13,676 109 25 13,761
Obligations of states and political subdivisions................ 54,957 915 12 55,860
Corporate securities............................................ 9,215 155 6 9,364
Collateralized mortgage obligations............................. 7,637 5 21 7,620
--
----------- ----- -----------
Total....................................................... $ 85,485 1,184 64 86,605
--
--
----------- ----- -----------
----------- ----- -----------
</TABLE>

F-12
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(2) INVESTMENTS (Continued)
The amortized cost and estimated fair value of fixed maturities classified
as available for sale at December 31, 1996 and June 30, 1997 by the earlier of
the pre-escrowed date or contractual maturity are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.

<TABLE>
<CAPTION>
DECEMBER 31, 1996
------------------------
AMORTIZED ESTIMATED
COST FAIR VALUE
----------- -----------
<S> <C> <C>
Due in one year or less.............................................. $ 13,516 13,623
Due after one year through five years................................ 28,898 29,286
Due after five years through ten years............................... 30,813 31,458
Collateralized mortgage obligations.................................. 7,025 7,004
----------- -----------
$ 80,252 81,371
----------- -----------
----------- -----------
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1997
------------------------
AMORTIZED ESTIMATED
COST FAIR VALUE
----------- -----------
<S> <C> <C>
Due in one year or less.............................................. $ 10,954 10,993
Due after one year through five years................................ 48,191 48,979
Due after five years through ten years............................... 18,703 19,013
Collateralized mortgage obligations.................................. 7,637 7,620
----------- -----------
$ 85,485 86,605
----------- -----------
----------- -----------
</TABLE>

Fixed maturities with a book value of $66,955 and $67,769 were on deposit
with various regulatory authorities as of December 31, 1996 and June 30, 1997,
respectively, as required.

PREFERRED STOCK

Unrealized investment gains (losses) on preferred stock at December 31, 1995
and 1996 and June 30, 1997 are as follows:

<TABLE>
<CAPTION>
DECEMBER 31
---------------------- JUNE 30
1995 1996 1997
--------- ----- -------------
<S> <C> <C> <C>
Gross unrealized gains............................................. $ -- 19 38
Gross unrealized losses............................................ -- -- --
-- --
---------
$ -- 19 38
-- --
-- --
---------
---------
</TABLE>

F-13
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(2) INVESTMENTS (Continued)

COMMON STOCK

Unrealized investment gains (losses) on common stock at December 31, 1995
and 1996 and June 30, 1997 are as follows:

<TABLE>
<CAPTION>
DECEMBER 31
---------------------- JUNE 30
1995 1996 1997
--------- ----- -----------
<S> <C> <C> <C>
Gross unrealized gains...................................... $ 27 72 172
Gross unrealized losses..................................... (71) (29) (22)
--
--- ---
$ (44) 43 150
--
--
--- ---
--- ---
</TABLE>

NET INVESTMENT INCOME

Net investment income is summarized as follows:

<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------- ------------------------
1994 1995 1996 1997
--------- --------- --------- 1996 ---------
-------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Interest.............................. $ 4,669 4,963 4,839 2,382 2,518
Dividends............................. 87 51 62 31 74
--------- --------- --------- ----- ---------
4,756 5,014 4,901 2,413 2,592
Less investment expenses.............. (220) (197) (200) (91) (93)
--------- --------- --------- ----- ---------
$ 4,536 4,817 4,701 2,322 2,499
--------- --------- --------- ----- ---------
--------- --------- --------- ----- ---------
</TABLE>

An affiliate of a significant holder of the Company's preferred stock also
acts as the Company's investment advisor. Fees paid for such investment services
totaled $119 and $146 in 1995 and 1996, respectively. For the six months ended
June 30, 1996 and 1997, such fees totaled $74 (unaudited) and $81, respectively.

NET REALIZED INVESTMENT GAINS (LOSSES)

Net realized investment gains (losses) are as follows:

Common stock:
Gross realized gains................ 23 -- -- -- --
Gross realized losses............... (39) -- -- -- --
--------- --------- --------- ----- ---------
$ -- 37 444 427 --
--------- --------- --------- ----- ---------
--------- --------- --------- ----- ---------
</TABLE>

F-14
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(3) UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liability for unpaid losses and loss adjustment expenses is
summarized as follows:

<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------- ----------------------
1994 1995 1996 1997
--------- --------- --------- 1996 ---------
-----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.... $ 62,629 60,473 57,049 57,049 55,720
Less reinsurance recoverable on
unpaid losses and loss
adjustment expenses........... 5,402 6,886 6,775 6,775 6,427
--------- --------- --------- ----------- ---------
Net balance at beginning of
period........................... 57,227 53,587 50,274 50,274 49,293
--------- --------- --------- ----------- ---------

Incurred related to:
Current period.................. 32,677 33,261 36,554 16,841 29,245
Prior periods................... (4,059) (3,898) (2,654) (2,904) (798)
--------- --------- --------- ----------- ---------
Total incurred................ 28,618 29,363 33,900 13,937 28,447
--------- --------- --------- ----------- ---------
Paid related to:
Current period.................. 10,455 10,870 13,143 3,862 5,130
Prior periods................... 21,803 21,806 21,738 12,487 14,075
--------- --------- --------- ----------- ---------
Total paid.................... 32,258 32,676 34,881 16,349 19,205
--------- --------- --------- ----------- ---------
Net balance at end of period...... 53,587 50,274 49,293 47,862 58,535
Plus reinsurance recoverable on
unpaid losses and loss
adjustment expenses........... 6,886 6,775 6,427 6,427 6,437
--------- --------- --------- ----------- ---------
Balance at end of period.......... $ 60,473 57,049 55,720 54,289 64,972
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
</TABLE>

The favorable development in the liability for unpaid losses and loss
adjustment expenses for prior years relates principally to reduced claim
frequency and stable severity.

(4) NOTES PAYABLE

The Company has issued notes payable to current and retiring employees for
repurchase of Company common stock, which are due in annual installments with
initial terms ranging from one to six years. Interest, expensed monthly, is
adjusted to prime at various specified dates each year.

F-15
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(4) NOTES PAYABLE (Continued)
A summary of notes payable at December 31, 1995 and 1996 and June 30, 1997
is as follows:

<TABLE>
<CAPTION>
DECEMBER 31
-------------------- JUNE 30,
1995 1996 1997
--------- --------- -----------
<S> <C> <C> <C>
Notes payable to former stockholders (interest 8.75% at December 31, 1995 and 1996,
and 8.25% at June 30, 1997 due at various dates through January 1999), secured by
420,034 shares and 283,188 shares of the Company's common stock at December 31,
1995 and 1996, respectively, and 146,342 shares at June 30, 1997................... $ 4,672 3,143 1,614
Notes payable to former stockholders (interest at 8.5% and 8.25% at December 31,
1995 and 1996, respectively, due at various dates through 1997), unsecured......... 157 51 --
Note payable (interest at 8.75% and 8.25% at December 31, 1995 and 1996,
respectively, and 8.25% at June 30, 1997 due 1998), unsecured...................... 154 105 78
Note payable (interest at 0.0% at December 31, 1996 and June 30, 1997, due 1999)
unsecured.......................................................................... -- 269 219
Notes payable of employee stock ownership plan (interest at 8.75% and 8.25% at
December 31, 1995 and 1996, respectively, and 8.25% at June 30, 1997 due March
1999), secured by 53,928 shares and 37,014 shares of the Company's common stock at
December 31, 1995 and 1996, respectively, and 32,748 shares at June 30, 1997,
guaranteed by the Company.......................................................... 319 221 196
--------- --------- -----
$ 5,302 3,789 2,107
--------- --------- -----
--------- --------- -----
</TABLE>

Aggregate annual commitments under notes payable are as follows at December
31, 1996:

Aggregate annual commitments under notes payable are as follows at June 30,
1997:

Total interest paid by the Company on all notes during the years ended
December 31, 1994, 1995 and 1996 was $188, $419 and $1,300, respectively. Total
interest paid by the Company for the six months ended June 30, 1996 and 1997 was
$677 (unaudited) and $473, respectively.

F-16
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(5) NOTE PAYABLE TO BANK

At December 31, 1995 and 1996, the Company had an unsecured line of credit
with a commercial bank of $10,500. As of December 31, 1996, the Company had
drawn $7,490 on the line of credit. The interest rate on the line of credit was
based on various indices. The average interest rate at December 31, 1996 was
7.8%. The line of credit required no principal payments during its term and
matured December 31, 1998. The line of credit imposed certain financial
covenants.

On March 31, 1997, the Company entered into a $15,000 unsecured line of
credit with another commercial bank. The line of credit requires no principal
payments during its term and matures December 31, 1999 and, at the Company's
option, converts to a two-year term note. The interest rate on the line of
credit is based on various indices. The line of credit imposes certain financial
covenants. On March 31, 1997, the Company drew on the line of credit to repay in
full and terminate the first line of credit.

As of June 30, 1997, the Company had an outstanding balance of $9,361 on the
line of credit. The average interest rate at June 30, 1997 was 7.6%.

F-17
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(6) INCOME TAXES

The Company and its subsidiaries file a consolidated Federal income tax
return. Income tax expense (benefit) for the years ended December 31, 1994, 1995
and 1996 is shown as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, FEDERAL STATE TOTAL
- ---------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
1994:
Current....................................................... $ 1,698 (7) 1,691
Deferred...................................................... (119) -- (119)
--------- --------- ---------
$ 1,579 (7) 1,572
--------- --------- ---------
--------- --------- ---------
1995:
Current....................................................... $ (1,615) 25 (1,590)
Deferred...................................................... 799 -- 799
--------- --------- ---------
$ (816) 25 (791)
--------- --------- ---------
--------- --------- ---------
1996:
Current....................................................... $ 1,079 30 1,109
Deferred...................................................... (282) -- (282)
--------- --------- ---------
$ 797 30 827
--------- --------- ---------
--------- --------- ---------
</TABLE>

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
- ----------------------------------------------------------------
<S> <C> <C> <C>
1996 (unaudited)
Current....................................................... $ 474 4 478
Deferred...................................................... (35) -- (35)
--------- --------- ---------
$ 439 4 443
--------- --------- ---------
--------- --------- ---------
1997
Current....................................................... $ (233) 14 (219)
Deferred...................................................... 757 -- 757
--------- --------- ---------
$ 524 14 538
--------- --------- ---------
--------- --------- ---------
</TABLE>

F-18
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(6) INCOME TAXES (Continued)

The total tax expense (benefit) is different from the applicable Federal
income tax rate of 34% for the reasons reflected in the following
reconciliation:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
------------------------------- --------------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Expected tax expense (benefit)................................... $ 2,134 (167) 1,615 852 963
Municipal bond interest.......................................... (615) (688) (782) (417) (417)
Dividends-received deduction..................................... (17) (10) (5) (2) (6)
Nondeductible expenses........................................... 61 55 55 28 33
State income taxes, net of Federal benefit....................... (4) 17 20 3 10
Other, net....................................................... 13 2 (76) (21) (45)
--------- --- --------- --- ---
$ 1,572 (791) 827 443 538
--------- --- --------- --- ---
--------- --- --------- --- ---
</TABLE>

Temporary differences which give rise to a significant portion of deferred
tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
DECEMBER 31
-------------------- JUNE 30
1995 1996 1997
--------- --------- -----------
<S> <C> <C> <C>
Deferred tax assets:
Loss reserve discounting..................................................... $ 4,041 3,917 4,591
Policyholder dividends....................................................... 1,594 1,354 1,219
Unearned premiums............................................................ 313 725 909
Unbilled premiums............................................................ 410 329 410
Other........................................................................ 406 778 593
--------- --------- -----------
Gross deferred tax assets................................................ 6,764 7,103 7,722
--------- --------- -----------
Deferred tax liabilities:
Unbilled premiums............................................................ (1,779) (1,795) (2,635)
Tax on net unrealized gain on securities carried at market value............. (787) (401) (444)
Other........................................................................ (37) (78) (614)
--------- --------- -----------
Gross deferred tax liabilities........................................... (2,603) (2,274) (3,693)
--------- --------- -----------
Net deferred tax asset................................................... $ 4,161 4,829 4,029
--------- --------- -----------
--------- --------- -----------
</TABLE>

The recoverability of the net deferred tax asset is demonstrated by taxes
paid in prior years and available tax planning strategies. Management believes
that it is more likely than not that the results of future operations and
various tax planning strategies will generate sufficient taxable income in the
periods necessary to realize the net deferred tax asset.

The Company paid $2,103, $375 and $1,400 of Federal income taxes during the
years ended December 31, 1994, 1995 and 1996, respectively. The Company paid $0
(unaudited) and $1,300 for the six months ended June 30, 1996 and 1997,
respectively.

F-19
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(7) REINSURANCE

In the ordinary course of business, the insurance subsidiaries cede
insurance for the purpose of obtaining greater risk diversification and
minimizing the maximum net loss potential arising from large claims. The
insurance subsidiaries, however, are contingently liable in the event that their
reinsurers become unable to meet their contractual obligations. A large portion
of the reinsurance is effected under reinsurance contracts known as treaties.
PAULA Insurance Company (PICO) maintains excess of loss and catastrophic
reinsurance arrangements to protect it against losses above its retention on
workers' compensation policies. The maximum retention on workers' compensation
policies is $200 in 1994 through June 30, 1996 and $250 for the last six months
of 1996 and 1997 for each loss occurrence.

The following amounts have been deducted in the accompanying consolidated
financial statements as a result of reinsurance ceded:

Substantially all reinsurance balances are with General Reinsurance Corporation.

(8) STOCKHOLDERS' EQUITY

In August 1994, the Company completed a private placement of 941,177 shares
of Series A -- convertible preferred stock. Gross proceeds of $16,000 were
received from three institutional investor groups which obtained the stock for
their own portfolios or investment funds. In addition to a cash commission paid
in connection with the private placement, the Company issued warrants to
purchase 164,706 shares of common stock at the fair market value at the date of
issuance of $8.50 per share to the placement agents. The offering was initiated
to strengthen the Company's capital position, to provide some liquidity to the
ESOP and to provide funds to assist the Company in its long-term goal to expand
its operations.

The preferred stock has dividend and voting rights consistent with common
stockholders on an if-converted basis, and has a liquidation preference of
$17.00 per share plus all accrued and unpaid dividends. The preferred stock is
convertible into common shares on a one-for-two basis at the holder's option or
automatically upon consummation of a qualified initial public offering with
aggregate proceeds in excess of $20,000 and a per share price greater than
$12.75 (a "Qualified Initial Public Offering"). The preferred stock is
redeemable at the holder's option beginning December 31, 1998 at the greater of
fair value as determined by an independent party or 1.15 times the Company's
book value per share assuming conversion of the preferred stock. Such redemption
right terminates upon the effectiveness of a registration statement for a
Qualified Initial Public Offering. The preferred stock restricts both dividend
payments and the repurchase of stock from the Company's employees and directors
so long as the preferred stock remains outstanding. The preferred stock purchase
agreement imposes certain additional covenants. The carrying value of the
preferred stock is accreted based on the redemption formula outlined in the
preferred stock agreement.

F-20
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(8) STOCKHOLDERS' EQUITY (Continued)
In January 1995, the Company agreed to repurchase 518,618 shares of common
stock and options to acquire 40,000 shares, for a purchase price of $11.25 per
share and $2.75 per option, from the retiring Chairman of the Board. The per
share price was based on a third-party offer. The amount of the repurchase
totaled $6,284, of which $1,486 was paid in each of January 1995 and 1996. The
remaining balance is included in a note payable with annual principal and
interest payments through 1998. The interest rate on the note equals the prime
rate. At June 30, 1997, the outstanding balance on the note was $1,486.

Upon reincorporation of the Company as a Delaware corporation, the par value
of the common and preferred stock was changed to $0.01 from no par value stock
and the number of common shares authorized was increased from 10,000,000 to
15,000,000.

The Company is obligated under the terms of its ESOP to repurchase shares
allocated to ESOP participants when the participants qualify for a distribution
(i.e., retirement or break in service) in the event the participants choose to
sell such shares and the ESOP is unable to repurchase the shares directly (see
note 9).

The purchase price of the Company's shares has historically been evaluated
and determined annually by an independent appraisal firm, as required, and is
approved by the ESOP committee. This appraisal is used for determining the
market value of the shares with respect to the ESOP.

PAULA Financial is dependent on the transfer of funds from its subsidiaries.
Dividends and advances from PICO and PACO are restricted by law and minimum
capitalization requirements and, above certain thresholds, subject to approval
by insurance regulatory authorities. Net assets of the insurance subsidiaries in
the amount of $37,403, $39,800 and $42,812 at December 31, 1995 and 1996 and
June 30, 1997, respectively, are restricted as to their availability for
advances or dividends to PAULA Financial due to insurance regulatory
requirements.

(9) EMPLOYEE BENEFIT PLANS

The Company maintains a defined contribution employee stock ownership plan
(ESOP) covering all full-time employees, excluding hourly employees. The ESOP
has assets principally comprised of 1,094,126 shares of the Company's common
stock at December 31, 1995 and 1996 and 1,094,126 shares at June 30, 1997. The
Company can make annual contributions to the ESOP in cash or shares of the
Company's common stock in amounts determined by the Company's Board of
Directors, except that such contributions must be in cash to the extent the ESOP
requires liquid funds to meet its obligations. The Company expensed cash
contributions of $150 in each of the years ended December 31, 1994, 1995 and
1996. The Company expensed cash contributions of $75 (unaudited) and $76 for the
six months ended June 30, 1996 and 1997, respectively.

The Company is obligated under the terms of its ESOP to repurchase shares
distributed to ESOP participants when the participants qualify for a
distribution (i.e., retirement or break in service) in the event the
participants choose to sell such shares and the ESOP is unable to repurchase the
shares directly. Such shares must be paid for within five years. This
commitment, if all shares were distributed, would be approximately $11,449 as of
December 31, 1996 and $11,495 at June 30, 1997.

F-21
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(9) EMPLOYEE BENEFIT PLANS (Continued)
During 1994, the Company repurchased 735,294 shares of common stock from the
ESOP with funds obtained from the preferred stock private placement. This
provided the ESOP with a cash flow of $6,250.

The Company maintains a 401(k) plan covering substantially all employees.
Employees may contribute up to 17% of their compensation. The Company makes a
matching contribution of 50% of the employee contribution, limited to 6% of
compensation. Total employer costs under the plan were $192, $208 and $208 for
the years ended December 31, 1994, 1995 and 1996, respectively. Total employer
costs under the plan were $95 (unaudited) and $115 for the six months ended June
30, 1996 and 1997, respectively.

Employees of the Company receive an annual year-end bonus based upon the
profitability of the Company. Amounts expensed under bonus programs were $871,
$427 and $1,053 for the years ended December 31, 1994, 1995 and 1996,
respectively. Amounts expensed under these bonus programs were $369 (unaudited)
and $295 for the six months ended June 30, 1996 and 1997, respectively.

In 1994, the Company adopted a stock incentive plan, reserving 550,000
shares of common stock, which provides for granting of stock options and
restricted stock bonuses to officers and directors and key employees of the
Company. Options and restricted stock are granted at the discretion of the
Executive Compensation Committee of the Board of Directors. Options are granted
at fair value as determined by the Executive Compensation Committee of the Board
of Directors.

Stock options vest either immediately or over periods not to exceed five
years and carry an exercise price equal to or in excess of the fair market value
of the common stock on the date of grant. The stock options are exercisable for
a ten-year term.

F-22
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(9) EMPLOYEE BENEFIT PLANS (Continued)
Changes in the status of options granted under the plan are summarized as
follows:

<TABLE>
<CAPTION>
1994
-------------------------------------------
WEIGHTED
EXERCISE AVERAGE
SHARES PRICE EXERCISE PRICE
--------- --------------- ---------------
<S> <C> <C> <C>
Beginning of year............................... -- $ -- --
Granted..................................... 167,300 8.50 - 9.03 8.53
Canceled.................................... -- -- --
Exercised or redeemed....................... -- -- --
--------- --------------- -----
End of year..................................... 167,300 $ 8.50 - 9.03 8.53
--------- --------------- -----
--------- --------------- -----
Exercisable..................................... 167,300 $ 8.50 - 9.03 8.53
--------- --------------- -----
--------- --------------- -----
</TABLE>

<TABLE>
<CAPTION>
1995
-------------------------------------------
WEIGHTED
EXERCISE AVERAGE
SHARES PRICE EXERCISE PRICE
--------- --------------- ---------------
<S> <C> <C> <C>
Beginning of year............................... 167,300 $ 8.50 - 9.03 8.53
Granted..................................... 31,000 9.03 9.03
Canceled.................................... (2,350) 9.03 9.03
Exercised or redeemed....................... (80,000) 8.50 8.50
--------- --------------- -----
End of year..................................... 115,950 $ 8.50 - 9.03 8.67
--------- --------------- -----
--------- --------------- -----
Exercisable..................................... 95,000 $ 8.50 - 9.03 8.67
--------- --------------- -----
--------- --------------- -----
</TABLE>

<TABLE>
<CAPTION>
1996
-------------------------------------------
WEIGHTED
EXERCISE AVERAGE
SHARES PRICE EXERCISE PRICE
--------- --------------- ---------------
<S> <C> <C> <C>
Beginning of year............................... 115,950 $ 8.50 - 9.03 8,67
Granted..................................... 289,300 7.88 - 12.50 8.83
Canceled.................................... (600) 9.03 9.03
Exercised or redeemed....................... -- -- --
--------- --------------- -----
End of year..................................... 404,650 $ 7.88 - 12.50 8.78
--------- --------------- -----
--------- --------------- -----
Exercisable..................................... 280,700 $ 7.88 - 12.50 8.78
--------- --------------- -----
--------- --------------- -----
</TABLE>

No options have been granted, cancelled, exercised or redeemed during the
six months ended June 30, 1997.

Pursuant to the plan, the Company granted 28,700 shares at $9.03 per share
and 22,500 shares at $7.88 per share of restricted common stock in 1995 and
1996, respectively. The per share price for these

F-23
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(9) EMPLOYEE BENEFIT PLANS (Continued)
awards was based on an annual independent appraisal. The restrictions lapse
pursuant to various vesting schedules. Holders of restricted stock are entitled
to vote such shares and receive dividends, which are not subject to
restrictions. As of December 31, 1996, the restrictions on an aggregate of 3,400
shares of restricted stock have lapsed; 9,500 and 1,400 shares in 1995 and 1996,
respectively, were forfeited based upon voluntary termination. No restricted
stock was granted in the six months ending June 30, 1997, and 200 shares were
forfeited based upon voluntary termination.

At December 31, 1996, 25,050 shares of common stock were available for
issuance under the plan. At June 30, 1997, 25,250 shares were available for
issuance under the plan.

In addition, in 1996, the Company issued options to purchase an aggregate of
316,000 shares of common stock to officers and directors of the Company outside
the Plan. The options carry an exercise price of $9.50 per share. Also,
outstanding is an option to purchase an aggregate of 60,000 shares of common
stock to an officer of the Company outside of the plan granted at $8.50 per
share in 1994. The options were granted at fair value as determined by the
Executive Compensation Committee of the Board of Directors. Such options have
the same terms as options granted under the plan and are immediately
exercisable.

In 1997, the Company adopted its 1997 Stock Incentive Plan, reserving
200,000 shares of common stock, none of which have been granted as of June 30,
1997.

The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (Opinion 25), and related
interpretations in accounting for its employee stock options and adopt the
disclosure requirements of Statement of Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (Statement 123). Had compensation cost
for the Company's stock-based compensation plan been reflected in the
accompanying consolidated financial statements based on the fair value at the
grant dates for option awards consistent with the method of Statement 123, the
Company's net income would have been reduced to the pro forma amounts indicated
below:

<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE
-------------------- 30,
1995 1996 1997
--------- --------- -------------
<S> <C> <C> <C>
As reported $ 300 3,923 2,294
Pro forma 257 3,326 2,151
--------- --------- -----
--------- --------- -----
</TABLE>

The fair value for these options was estimated at the date of grant using
the minimum value method. The risk free interest rate used for options granted
during 1995 and 1996 was 6.4%. An average option exercise period of seven years
was used. Pro forma net income reflects only options granted in 1995 and 1996.
During the initial phase-in period of Statement 123, the full impact of
calculating compensation cost for stock options is not reflected in the pro
forma net income amounts presented above because compensation cost is reflected
over the options' vesting periods and compensation cost for options granted
prior to January 1, 1995 is not considered.

F-24
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(10) STATUTORY ACCOUNTING PRACTICES

The insurance subsidiaries are required to file statutory financial
statements with state insurance regulatory authorities. Accounting practices
used to prepare these statutory financial statements differ from generally
accepted accounting principles (GAAP). Such differences include the following:
(1) reserves for losses and loss adjustment expenses must meet certain minimum
requirements, (2) reserves for policyholder dividends are recorded as a
restriction on surplus until declared, (3) Federal income taxes are recorded
when payable, (4) fixed maturities are carried at admitted values, (5) certain
assets are non-admitted and (6) acquisition expenses are expensed when incurred.
Amounts reported to regulatory authorities as compared to amounts included in
the accompanying consolidated financial statements on a GAAP basis for the years
ended December 31, 1994, 1995 and 1996 and the six months ended June 30, 1996
and 1997 follow:

<TABLE>
<CAPTION>
AS INCLUDED
IN THE
ACCOMPANYING
CONSOLIDATED AS REPORTED
FINANCIAL TO REGULATORY
STATEMENTS AUTHORITIES
-------------- -------------
<S> <C> <C>
Years ended December 31
1994:
Net earnings................................................ $ 5,366 5,368
-------------- -------------
-------------- -------------
Stockholders' equity........................................ $ 38,146 19,381
-------------- -------------
-------------- -------------
1995:
Net earnings................................................ $ 2,052 3,122
-------------- -------------
-------------- -------------
Stockholders' equity........................................ $ 41,003 30,271
-------------- -------------
-------------- -------------
1996:
Net earnings................................................ $ 5,770 5,080
-------------- -------------
-------------- -------------
Stockholders' equity........................................ $ 45,202 35,144
-------------- -------------
-------------- -------------
Six months ended June 30
1996 (unaudited):
Net earnings................................................ $ 2,470 1,935
-------------- -------------
-------------- -------------
Stockholders' equity........................................ $ 42,269 32,060
-------------- -------------
-------------- -------------
1997:
Net earnings................................................ $ 2,927 2,972
-------------- -------------
-------------- -------------
Stockholders' equity........................................ $ 48,214 35,901
-------------- -------------
-------------- -------------
</TABLE>

Statutory accounting practices for the insurance subsidiaries are prescribed
or permitted by the Department of Insurance of the State of California.
Prescribed accounting practices include a variety of publications of the
National Association of Insurance Commissioners (NAIC) as well as state laws,
regulations and general administrative rules. Permitted statutory accounting
practices encompass all accounting practices that are not prescribed; such
practices differ from state to state, may differ from company to company within
a state and may change in the future. Furthermore, the National Association

F-25
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(10) STATUTORY ACCOUNTING PRACTICES (Continued)
of Insurance Commissioners has a project to codify statutory accounting
practices, the result of which is expected to constitute the only source of
"prescribed" statutory accounting practices. Accordingly, that project will
likely change the definition of what comprises prescribed versus permitted
statutory accounting practices and may result in changes to the accounting
policies that insurance enterprises use to prepare their statutory financial
statements.

Insurance regulatory authorities impose various restrictions on the payment
of dividends and advances by insurance companies. As of December 31, 1996, the
maximum dividend and advance payments that may be made during 1997 by the
insurance subsidiaries to PAULA Financial without prior approval of the
regulatory authorities are limited to the greater of net income for the
preceding year or 10% of policyholder surplus as of the preceding December 31
and approximate $5.4 million.

(11) COMMITMENTS AND CONTINGENCIES

The Company leases buildings for its home office and certain other premises
under long-term operating leases that expire in various years to 2002. Certain
of these leases are with related parties. Rent expense was $1,342, $1,483 and
$1,657 for the years ended December 31, 1994, 1995 and 1996, respectively. Rent
expense for the six months ended June 30, 1996 and 1997 was $798 (unaudited) and
$777, respectively. Included in rent expense is rent paid to related parties of
the Company totaling $129, $230 and $149 for the years ended December 31, 1994,
1995 and 1996, respectively and $91 (unaudited) and $52 for the six months ended
June 30, 1996 and 1997, respectively.

Approximate aggregate minimum rental commitments under operating leases at
December 31, 1996 are as follows:

<TABLE>
<S> <C>
1997............................................................... $ 1,399
1998............................................................... 1,425
1999............................................................... 682
2000............................................................... 211
2001 and thereafter................................................ 186
---------
$ 3,903
---------
---------
</TABLE>

Approximate aggregate minimum rental commitments under operating leases at
June 30, 1997 are as follows:

<TABLE>
<S> <C>
1997............................................................... $ 717
1998............................................................... 1,425
1999............................................................... 682
2000............................................................... 211
2001 and thereafter................................................ 186
---------
$ 3,221
---------
---------
</TABLE>

Certain of these leases contain renewal provisions.

F-26
<PAGE>
PAULA FINANCIAL AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)

(11) COMMITMENTS AND CONTINGENCIES (Continued)
In the ordinary course of business, the Company's subsidiaries are
defendants in various lawsuits. Management believes that the ultimate
disposition of the litigation will not result in a material impact to the
financial position or operating results of the Company.

The NAIC has adopted a risk-based capital formula for both property and
casualty and life insurance companies. These formulas calculate a minimum level
of capital and surplus which should be maintained by each insurer. At December
31, 1996, both PICO and PACO's adjusted capital and surplus exceeded their
respective risk-based capital requirements.

(12) ACQUISITIONS

In December 1994, the Company acquired the assets of the predecessors of
Agri-Comp Insurance Agency, Inc. for a purchase price of $1,800. The acquisition
has been accounted for using the purchase method of accounting and the
operations from the date of acquisition have been included in the accompanying
consolidated financial statements. The purchase price has principally been
allocated to the excess of cost over net assets acquired.

In November 1995, the Company acquired the assets of Desert Benefits, Inc.,
an insurance agency specializing in agribusiness and rural market medical
benefit programs, for total consideration of $700. The purchase price was
comprised of a $140 cash payment and the issuance of common stock for the
remaining balance (71,066 shares). The acquisition has been accounted for using
the purchase method of accounting and the operations have been included in the
accompanying consolidated financial statements from the date of acquisition. The
purchase price has principally been allocated to the excess of cost over net
assets acquired.

In August 1996, the Company acquired the assets of Guinn Sinclair Insurance
Services, an insurance agency specializing in farm labor contractor insurance
needs, for total consideration of $221. The purchase price was comprised of a
$44 cash payment and the issuance of common stock for the remaining balance
(11,764 shares). The acquisition has been accounted for as an asset purchase and
the operations have been included in the accompanying consolidated financial
statements from the date of acquisition. The purchase price has principally been
allocated to the excess of cost over net assets acquired.

(13) SUBSEQUENT EVENT

On September 23, 1997, the Company declared a two-for-one stock split
effected in the form of a dividend to stockholders of record on September 23,
1997.

All data with respect to equity classification, earnings per share and share
information, including price per share, where applicable, in the consolidated
financial statements and notes thereto have been retroactively adjusted to
reflect the split.

F-27
<PAGE>
UNDERWRITING

Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
Underwriters named below, and each of such Underwriters, for whom Goldman, Sachs
& Co. and Conning & Company are acting as representatives, has severally agreed
to purchase from the Company and the Selling Stockholders, the respective number
of shares of Common Stock set forth opposite its name below:

<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
COMMON
UNDERWRITER STOCK
- ------------------------------------------------------------------------------------------- -----------
<S> <C>
Goldman, Sachs & Co........................................................................ 966,000
Conning & Company.......................................................................... 966,000
BT Alex. Brown Incorporated................................................................ 85,000
Donaldson, Lufkin & Jenrette Securities Corporation........................................ 85,000
Dowling & Partners Securities, LLC......................................................... 57,000
Hoefer & Arnett, Incorporated.............................................................. 57,000
Oppenheimer & Co., Inc..................................................................... 85,000
Roney & Co., LLC........................................................................... 57,000
Sands Brothers & Co., Ltd.................................................................. 57,000
Wasserstein Perella Securities, Inc........................................................ 85,000
-----------
Total.................................................................................. 2,500,000
-----------
-----------
</TABLE>

Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.

The Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus and in part to certain securities dealers at such
price less a concession of $.78 per share. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $.10 per share to certain
brokers and dealers. After the shares of Common Stock are released for sale to
the public, the offering price and other selling terms may from time to time be
varied by the representatives.

The Company and the Selling Shareholders have granted the Underwriters an
option exercisable for 30 days after the date of this Prospectus to purchase up
to an aggregate of 375,000 additional shares of Common Stock solely to cover
over-allotments, if any. If the Underwriters exercise their over-allotment
option, the Underwriters have severally agreed, subject to certain conditions,
to purchase approximately the same percentage thereof that the number of shares
to be purchased by each of them, as shown in the foregoing table, bears to the
2,500,000 shares of Common Stock offered.

The Company, its executive officers and directors, the ESOP and certain
other holders of Common Stock, which in the aggregate will hold approximately
48.5% of the outstanding shares of the Company after the offering, have agreed
that, during the period beginning from the date of this Prospectus and
continuing to and including the date 180 days after the date of this Prospectus,
they will not offer, sell, contract to sell or otherwise dispose of, or, with
certain exceptions, file or cause to be filed with the Commission a registration
statement with respect to, shares of Common Stock (other than, in the case of
the Company, pursuant to employee stock option plans existing, or on the
conversion or exchange of convertible or exchangeable securities outstanding, on
the date of this Prospectus and, in the case of the ESOP, distributions of
shares to the participants in the ESOP upon termination of such participants'
employment with the Company) or any securities of the Company which are
substantially similar to the shares of Common Stock or which are convertible
into or exchangeable for shares of Common Stock or securities which are
substantially similar to the shares of Common Stock without the prior written

U-1
<PAGE>
consent of the representatives, except for the shares of Common Stock offered in
connection with the offering.

Conning Asset Management, an affiliate of Conning & Company, acts as the
Company's investment advisor and receives customary compensation for its
services in such capacity. See "Business-- Investments and Investment Results"
and "Certain Transactions". In addition, Conning & Company beneficially owned in
the aggregate 25.4% of the Common Stock as of June 30, 1997 (15.8% upon
consummation of the offering). See "Principal and Selling Stockholders".
Pursuant to the provisions of the Preferred Stock Purchase Agreement, Conning &
Company has designated two members of the Company's Board of Directors. The
provisions of the Preferred Stock Purchase Agreement providing for such
designation will terminate upon consummation of the offering. See
"Management--Directors and Executive Officers".

Under Rule 2720 of the National Association of Securities Dealers, Inc. (the
"NASD"), the Company may be deemed an affiliate of Conning & Company. This
offering is being conducted in accordance with Rule 2720, which provides that,
among other things, when an NASD member participates in the underwriting of an
affiliate's equity securities, the initial public offering price can be no
higher than that recommended by a "qualified independent underwriter" meeting
certain standards. In accordance with this requirement, Goldman, Sachs & Co. has
served in such role and has recommended a price in compliance with the
requirements of Rule 2720. Goldman, Sachs & Co. will receive compensation from
the Company in the amount of $10,000 for serving in such role. In connection
with the offering, Goldman, Sachs & Co. in its role as qualified independent
underwriter has performed due diligence investigations and reviewed and
participated in the preparation of this Prospectus and the Registration
Statement of which this Prospectus forms a part. In addition, the Underwriters
may not confirm sales to any discretionary account without the prior specific
written approval of the customer.

In connection with the offering, the Underwriters may purchase and sell
shares of Common Stock in the open market. These transactions may include
over-allotment and stabilizing transactions and purchases to cover syndicate
short positions created in connection with the offering. Stabilizing
transactions consist of certain bids or purchases for the purpose of preventing
or retarding a decline in the market price of the shares of Common Stock; and
syndicate short positions involve the sale by the Underwriters of a greater
number of shares of Common Stock than they are required to purchase from the
Company in the offering. The Underwriters also may impose a penalty bid, whereby
selling concessions allowed to syndicate members or other broker-dealers in
respect of the securities sold in the offering for their account may be
reclaimed by the syndicate if such shares of Common Stock are repurchased by the
syndicate in stabilizing or covering transactions. These activities may
stabilize, maintain or otherwise affect the market price of the shares of Common
Stock, which may be higher than the price that might otherwise prevail in the
open market; and these activities, if commenced, may be discontinued at any
time. These transactions may be effected in the over-the-counter market or
otherwise.

Prior to this offering, there has been no public market for the shares. The
initial public offering price was negotiated among the Company and the
representatives. Among the factors considered in determining the initial public
offering price of the Common Stock, in addition to prevailing market conditions,
were the Company's historical performance, estimates of the business potential
and earnings prospects of the Company, an assessment of the Company's management
and the consideration of the above factors in relation to market valuation of
companies in related businesses.

The Common Stock will be quoted on the Nasdaq National Market under the
symbol "PFCO".

The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act of 1933.

U-2
<PAGE>
GLOSSARY OF SELECTED INSURANCE TERMS

The following terms when used in this Prospectus have the following meaning:

<TABLE>
<CAPTION>
<S> <C>
Accident Year............................. The calendar year in which the event giving rise to a claim occurs
regardless of the year during which the policy covering the event was
written.

Cede...................................... To transfer to a reinsurer all or a portion of a risk in consideration of a
premium.

Combined ratio............................ The sum of the loss ratio, the expense ratio and the policyholder dividend
ratio, expressed as a percentage, determined in accordance with either SAP
or GAAP.

Earned surplus............................ The cumulative amount of retained net profits from insurance operations,
including investment income, as determined under SAP.

Estimated Annual Premium ("EAP").......... As of any date, the sum of the estimated total annualized premiums for all
policies in force on that date, whether earned prior to or after such date.

Excess of loss reinsurance................ A form of reinsurance in which the reinsurer indemnifies the ceding company
against all or a portion of the amount of loss in excess of a specific
retention.

Expense ratio............................. The percentage arrived at by dividing the amount of underwriting expenses by
the amount of premium earned, in the case of a GAAP expense ratio, and
premium written, in the case of a SAP expense ratio.

Experience modification................... A factor applied to each policyholder's premium rates established by the
applicable statistical rating bureau which reflects the policyholder's
historical loss experience.

Frequency................................. The number of claims occurring under a given coverage divided by the number
of exposures for the given coverage.

GAAP...................................... Generally accepted accounting principles.

Incurred but not reported ("IBNR") Claims that have been incurred but not reported to the insurer.
claims....................................

Loss adjustment expenses ("LAE").......... The expenses of settling claims, including legal and other fees, and general
expenses of administering the claims adjustment process.

Loss ratio................................ For SAP and GAAP, net losses and loss adjustment expenses incurred, divided
by net premiums earned, expressed as a percentage.

Participating policy...................... An insurance policy where the policyholder may receive a "dividend", which
is a partial return of premium, after the expiration of a policy period,
subject to declaration by the Board of Directors.

Policyholder dividend ratio............... The percentage arrived at by dividing the amount of policyholder dividends
incurred by the amount of net premium earned.

Premiums earned........................... The amount of premiums recognized as revenue for accounting purposes during
a given period. Generally, premiums are earned ratably over the term of the
related policy.
</TABLE>

G-1
<PAGE>
<TABLE>
<CAPTION>
Premiums written.......................... Gross premiums received by an insurer during a given period.
<S> <C>

Reinsurance............................... A procedure whereby an original insurer remits a portion of the premium to a
reinsurer as payment for the reinsurer's assumption of all or a portion of
the risk.

Reserve for losses and LAE................ The estimated liability for unpaid losses and LAE representing estimates of
amounts needed to pay and settle reported and unreported claims and the
related LAE.

Statutory Accounting Practices or "SAP"... Recording accounting transactions and preparing financial statements in
accordance with the rules and procedures prescribed or permitted by state
insurance regulatory agencies. The principal differences between SAP and
GAAP are as follows: (a) under SAP, certain assets (nonadmitted assets) are
eliminated from the balance sheet; (b) under SAP, policy acquisition costs
are expensed upon policy inception, while under GAAP they are deferred and
amortized over the term of the policies; (c) under SAP, no provision is made
for deferred income taxes; and (d) under SAP, certain reserves are
recognized which are not recognized under GAAP.

Severity.................................. The cost of a claim under an insurance policy.

Statutory surplus......................... The amount remaining after all liabilities are subtracted from all admitted
assets, as determined in accordance with SAP. This amount is regarded as
financial protection to policyholders in the event the insurance company
suffers unexpected or catastrophic losses.

Treaty.................................... A reinsurance agreement between the ceding company and the reinsurer,
typically for one year or longer, which stipulates the terms of the
reinsurance applicable to some class or classes of business.

Underwriting.............................. The process whereby an insurer reviews applications submitted for insurance
coverage and determines whether it will accept all or part, and at what
premium, of the coverage being requested.

Underwriting expenses..................... The aggregate of policy acquisition costs and the portion of administrative,
general and other expenses attributable to the underwriting process as they
are accrued and expensed.

Underwriting profit (loss)................ The amount of pretax income (loss) from insurance operations, exclusive of
net investment income and capital gains or losses.
</TABLE>

G-2
<PAGE>
A collage of logos of a representative list of the Company's endorsements will
appear with the heading, "PAULA's Representative Endorsements."

[LOGOS]

These logos are representative of trade associations and safety groups with
which the Company has relationships. As of June 30, 1997, members of all trade
associations and safety groups, including those represented above, accounted for
approximately 44% of the Company's Estimated Annual Premium ("EAP"). Members of
these trade associations and safety groups represented above accounted for
approximately 15% of the Company's EAP as of June 30, 1997.
<PAGE>
- ----------------------------------------------
----------------------------------------------
- ----------------------------------------------
----------------------------------------------

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
-----------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information..................................................... 3
Prospectus Summary........................................................ 4
Risk Factors.............................................................. 11
Use of Proceeds........................................................... 17
Dividend Policy........................................................... 17
Dilution.................................................................. 18
Capitalization............................................................ 19
Selected Financial Data................................................... 20
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 22
Business.................................................................. 30
Management................................................................ 59
Certain Transactions...................................................... 66
Principal and Selling Stockholders........................................ 67
Description of Capital Stock.............................................. 69
Shares Eligible for Future Sale........................................... 71
Validity of Common Stock.................................................. 73
Experts................................................................... 73
Index to Consolidated Financial Statements................................ F-1
Underwriting.............................................................. U-1
Glossary of Selected Insurance Terms...................................... G-1
</TABLE>

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

THROUGH AND INCLUDING NOVEMBER 17, 1997 (THE 25TH DAY AFTER THE DATE OF THIS
PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.

2,500,000 SHARES

PAULA FINANCIAL

COMMON STOCK
(PAR VALUE $.01 PER SHARE)

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

[ L O G O ]

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

GOLDMAN, SACHS & CO.
CONNING & COMPANY

REPRESENTATIVES OF THE UNDERWRITERS

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