<PAGE>

                                                                   EXHIBIT 10.21

                SEVENTH AMENDMENT AND WAIVER TO CREDIT AGREEMENT
                ------------------------------------------------

          SEVENTH AMENDMENT TO CREDIT AGREEMENT (this "Amendment"), dated as of
December 31, 2000, among HIGHLANDS INSURANCE GROUP, INC., a Delaware corporation
(the "Borrower"), the lenders party to the Credit Agreement referred to below
(the "Banks") and THE CHASE MANHATTAN BANK, as administrative agent (the
"Administrative Agent").  Unless otherwise defined herein, all capitalized terms
used herein and defined in the Credit Agreement are used herein as so defined.

                             W I T N E S S E T H :
                             -------------------

          WHEREAS, the Borrower, the Banks and the Administrative Agent are
parties to a Credit Agreement, dated as of April 30, 1997 (as amended, modified
or supplemented to, but not including, the date hereof, the "Credit Agreement");

          WHEREAS, the parties hereto wish to amend the Credit Agreement as
provided herein;

          NOW, THEREFORE, it is agreed:

          1.  The Banks hereby waive any Default or Event of Default that has
arisen as a result of the failure of the Borrower to deliver to the Banks the
documentation set forth in Section 6.01(a)(i), (ii) and (iv) of the Credit
Agreement, Section 6.01(c) of the Credit Agreement and Section 6.01(d) of the
Credit Agreement, in each case in respect of its fiscal year ended December 31,
2000; it being understood and agreed, however, in the event that any such
documentation is not delivered to the Banks on or prior to May 1, 2001, the
foregoing Defaults and Events of Default  shall automatically be reinstated on
such date at which time the waivers set forth in this Section 1 shall cease to
have any further force or effect.

          2.  Section 2.01 of the Credit Agreement is hereby amended by adding
the following new clause (d) at the end thereof:

                    "(d)  On the earlier of (i) the repayment of all outstanding
          Loans and the termination of the Total Commitment and (ii) December
          31, 2001, the Borrower shall pay to the Administrative Agent for the
          account of each Approving Bank an amendment fee equal to 0.45% of such
          Approving Bank's Commitment on the Seventh Amendment Effective Date."

          3.  Section 6.01 of the Credit Agreement is hereby amended by
inserting the following new clauses (l) and (m) at the end thereof:

                    "(l)  As soon as available and in any event within 5 days
          following the close of each fiscal month of the Borrower, a statement
          of the Borrower's sources and uses of cash for such month.

                    (m) Promptly and in any event within two Business Days
          following the receipt thereof, copies of any notifications or other
          correspondence the Borrower or any of its Subsidiaries receives from
          (i) the Commissioner or The Financial Program of the Texas Department
          of Insurance (including any such notice or correspondence informing
          any such Person that HIC may not make any Dividends to the Borrower)
          and (ii) S&P, Moody's or any other rating agency of the Borrower's
          debt or equity securities."

          4.  Notwithstanding anything to contrary contained in Section 7.02(f)
of the Credit Agreement or in any other provision of the Credit Agreement,
unless the Required Banks otherwise agree, from and
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after the Seventh Amendment Effective Date (as defined below), neither the
Borrower nor any of its Subsidiaries shall be permitted to consummate any
Permitted Acquisitions.

          5.  Notwithstanding anything to the contrary contained in Section
7.02(e)(i) (or elsewhere) of the Credit Agreement, the Banks hereby agree that
the Borrower or one of its Subsidiaries may sell for cash that certain Real
Property located at 1000 Lenox Drive, Lawrenceville, New Jersey so long as 100%
of the Net Cash Proceeds therefrom are applied to increase the Statutory Surplus
of Northwestern National, it being understood and agreed that from and after the
sale of such Real Property, no further sales or other dispositions of the
Borrower's or any of its Subsidiaries' property or assets may be made pursuant
to Section 7.02(e) of the Credit Agreement.

          6.  Section 7.04(k) of the Credit Agreement is hereby amended by
deleting the word "Other" appearing therein and adding the words "With the prior
written consent of the Required Banks, other" in lieu thereof.

          7.  Section 7.05 of the Credit Agreement is hereby amended by
inserting the text "With the prior written consent of the Required Banks" at the
beginning of clause (j) thereof.

          8.  Section 7.07(a) of the Credit Agreement is hereby amended by
adding the words "with the prior written consent of the Required Banks," at the
beginning of clauses "(ii)", "(iv)" and "(v)" thereof.

          9.  Section 7.09 of the Credit Agreement is hereby amended by deleting
said Section in its entirety and inserting the following Section 7.09 in lieu
thereof:

               "7.09 Creation of Subsidiaries. Unless the Required Banks
                     ------------------------
          otherwise agree, the Borrower shall not create or acquire any
          Subsidiary."

          10.  Section 7.11 of the Credit Agreement is hereby deleted in its
entirety and the following new Section 7.11 is inserted in lieu thereof:

               "7.11 Leverage Ratio.  The Borrower will not permit the ratio of
                     --------------
          (i) Consolidated Indebtedness to (ii) Total Capital (x) at any time
          during the Borrower's fiscal quarter ending December 31, 2000, to be
          greater than 40%, (y) at any time during the Borrower's fiscal year
          2001, to be greater than .45:1 and (z) at any time thereafter, to be
          greater than .31:1."

          11.  Section 7.12 of the Credit Agreement is hereby deleted in its
entirety and the following new Section 7.12 is hereby inserted in lieu thereof:

               "7.12 Interest Coverage Ratio.  The Borrower will not permit the
                     -----------------------
          Interest Coverage Ratio for any Test Period ending (i) on December 31,
          2000 to be less than 2.50:1.00, (ii) on September 30, 2001 to be less
          than 1.80:1.00, (iii) on December 31, 2001 to be less than 2.00:1.00
          and (iv) thereafter to be less than 2.50:1.00. "

          12.  Section 7.13 of the Credit Agreement is hereby deleted in its
entirety and the following new section 7.13 is hereby inserted in lieu thereof:

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               "7.13 Minimum Statutory Surplus.  (a) the Borrower will not
                     -------------------------
          permit HIC, on a combined basis, to have during any period set forth
          below a Statutory Surplus of less than the amount set forth below:

<TABLE>
<CAPTION>
          Period                                            Amount
          ------                                          -----------
          <S>                                            <C>
          From September 30, 2000 to
           and including December 31, 2000               $125,000,000

          January 1, 2001 to
           and including March 31, 2001                  $115,000,000

          April 1, 2001 to and including
           June 30, 2001                                 $115,000,000

          July 1, 2001 to and including
           September 30, 2001                            $120,000,000

          October 1, 2001 to and including
           December 31, 2001                             $125,000,000

          Thereafter                                     $185,000,000
</TABLE>
          (b) The Borrower will not permit VIK on a combined statutory basis to
          have during any period set forth below a Statutory Surplus of less
          than the amount set forth below:

<TABLE>
<CAPTION>
          Period                                Amount
          ------                              -----------
<S>                                           <C>
          From September 30, 2000 to and
           including December 31, 2000        $65,000,000

          January 1, 2001 to and including
           March 31, 2001                     $60,000,000

          April 1, 2001 to and including
           June 30, 2001                      $60,000,000

          July 1, 2001 to and including
           September 30, 2001                 $65,000,000

          October 1, 2001 to and including
           December 31, 2001                  $70,000,000

          Thereafter                          $100,000,000"
</TABLE>
          13.  Clause (a) of Section 7.14 of the Credit Agreement is hereby
deleted in its entirety and the following new clause (a) is hereby inserted in
lieu thereof:


               "(a) The Borrower will not permit the Risk-Based Capital for (x)
          HIC during (i) the Borrower's fiscal quarter ending December 31, 2000
          to be less than 205%, (ii) the Borrower's fiscal year 2001 to be less
          than 190% and (ii) thereafter to be less than 275% and (y)
          Northwestern National to be less than 275% at any time."

          14.  Section 7 of the Credit Agreement is hereby amended by inserting
the following new Sections 7.18 and 7.19 at the end thereof:

               "7.18  No Payment of Interest on the 10% Convertible Subordinated
                      ----------------------------------------------------------
          Debentures. The Borrower shall not, and shall not permit any of its
          ----------
          Subsidiaries to, make any payments of interest on the 10% Convertible
          Subordinated Debentures, provided that in lieu of paying interest on
          the 10% Convertible Subordinated Debentures that would otherwise be
          payable thereon on June 30, 2001 and December 31, 2001 (pursuant to
          the terms thereof on the Seventh Amendment Effective Date), the
          Borrower may issue, within

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          14 days following the Seventh Amendment Effective Date, new 12.5%
          convertible subordinated debentures in an aggregate principal amount
          not to exceed the interest that would otherwise be payable on such
          dates as long as such convertible subordinated debentures are in form
          and substance and have terms and conditions identical to the 10%
          Convertible Subordinated Debentures outstanding on the Seventh
          Amendment Effective Date, with such changes as may be acceptable to
          the Administrative Agent (such new convertible subordinated
          debentures, the "PIK Convertible Subordinated Debentures").

               7.19  Minimum Deposit in Interest Escrow Account.  The Borrower
                     ------------------------------------------
          will cause at least $3,000,000 to be maintained in the Interest Escrow
          Account at all times."

          15.  The definition of "Asset Sale" appearing in Section 9 of the
Credit Agreement is hereby amended by deleting clause (ii) appearing therein in
its entirety and inserting the following new clause (ii) in lieu thereof:

                    "(ii)  the sale of that certain Real Property located at
          1000 Lenox Drive, Lawrenceville, New Jersey so long as 100% of the Net
          Cash Proceeds therefrom are applied to increase the Statutory Surplus
          of Northwestern National".

          16.  The definition of Consolidated Interest Expense contained in
Section 9 of the Credit Agreement is hereby amended by inserting the following
proviso at the end thereof:

          ", provided that from and after the Seventh Amendment Effective Date,
          interest on the 10% Convertible Subordinated Debentures shall not be
          included in arriving at Consolidated Interest Expense for the relevant
          period so long as all such interest was paid in kind during such
          period rather than paid in cash."

          17.  The definition of "Maximum Dividends Available" appearing in
Section 9 of the Credit Agreement is hereby amended by deleting the proviso
contained therein in its entirety and inserting the following new proviso in
lieu thereof:

               "provided that, solely for purposes of determining compliance
                --------
          with Section 7.12 (and not for determining the Applicable Percentage
          or for any other purpose), for any Regulated Insurance Company ("RIC")
          for any Test Period ending in 2001, the "Maximum Dividends Available"
          shall mean the dividends permitted to be paid by such RIC to its
          parent company under applicable Legal Requirements during the fiscal
          year in which such Test Period occurs divided by (to the extent any
          such Test Period ends prior to December 31, 2001), in the case of any
          such Test Period ending on September 30, 2001, 4/3

          18.  The definition of 10% Convertible Subordinated Debentures is
hereby amended by inserting the following text at the end thereof:

          "and (ii) those certain PIK Convertible Subordinated Debentures issued
          in accordance with Section 7.18, as in effect upon the issuance
          thereof and as subsequently modified, amended, or supplemented as
          provided for therein and herein."

          19.  Section 9 of the Credit Agreement is hereby amended by deleting
the definition of "Test Period" appearing therein in its entirety and inserting
the following new definition of "Test Period" in lieu thereof:

               "Test Period" shall mean the four consecutive fiscal quarters of
          the Borrower then last ended provided that for purposes of Section
          7.12 for the quarter ending September 30, 2001, "Test Period" shall
          mean the period from January 1, 2001 to the last day of each such
          quarter.

                                      -4-
<PAGE>

          20.  Section 9 of the Credit Agreement is hereby amended by inserting
the following definitions in the proper alphabetical order:

          "Interest Escrow Account" shall mean that certain escrow account
          established pursuant to that certain Interest Escrow Account Agreement
          entered into between the Borrower and Chase, as collateral agent,
          pursuant to the Seventh Amendment.

          "PIK Convertible Subordinated Debentures" shall have the meaning
          provided for in Section 7.18.

          "Seventh Amendment" shall mean the Seventh Amendment to this Agreement
          among the Borrower and the Banks dated as of April 13, 2001.

          "Seventh Amendment Effective Date" shall mean April 13, 2001.

          21.  The Banks hereby agree that the 10% Convertible Subordinated
Debentures may be amended solely to provide that interest thereon shall be
payable in kind rather than in cash.

          22.  The Borrower and the Banks hereby agree that in the event that
the Borrower is required to restate, or voluntarily restates any or all of the
financial statements (or any information provided for therein) required to be
delivered pursuant to Section 6.01(a) of the Credit Agreement at any time
following the delivery thereof and as a result of any such restatement, the
Borrower shall not be in compliance with any of Sections 7.11 through 7.15,
inclusive, for the Test Period ended December 31, 2000 (or as of December 31,
2000, as the case may be), then on such date of restatement an Event of Default
under Section 8.03 of the Credit Agreement shall be deemed to have occurred.

          23.  Within five Business Days following the Seventh Amendment
Effective Date, the Borrower shall have executed and delivered to the
Administrative Agent an Interest Escrow Account Agreement in form and substance
satisfactory to the Administrative Agent.

          24.  In order to induce the Banks to enter into this Amendment, the
Borrower hereby represents and warrants that (i) the representations, warranties
and agreements contained in Section 5 of the Credit Agreement are true and
correct in all material respects on and as of the Seventh Amendment Effective
Date (as hereinafter defined) except to the extent such representations and
warranties expressly relate to an earlier date and (ii) there exists no Default
or Event of Default on the Seventh Amendment Effective Date after giving effect
to this Amendment.

          25.  This Amendment is limited as specified and shall not constitute a
modification, acceptance or waiver of any other provision of the Credit
Agreement or any other Credit Document.

          26.  This Amendment may be executed in any number of counterparts and
by the different parties hereto on separate counterparts, each of which
counterparts when executed and delivered shall be an original, but all of which
shall together constitute one and the same instrument.  A complete set of
counterparts shall be lodged with the Borrower and the Administrative Agent.

          27.  THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES
HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE
STATE OF NEW YORK.

          28.  This Amendment shall become effective as of the date first
referenced above on the date (the "Seventh Amendment Effective Date") when:

          (i) the Borrower and the Required Banks shall have signed a
counterpart hereof (whether the same or different counterparts) and shall have
delivered (including by way of facsimile) the same to the Administrative Agent
at the Notice Office, (ii) the Administrative Agent shall have received evidence
satisfactory to it that the 10%

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<PAGE>

Convertible Subordinated Debentures held by IP shall have been amended or
otherwise modified to provide that interest thereon shall at no time be payable
in cash from and after the Seventh Amendment Effective Date, (iii) the Borrower
shall have deposited $4,000,000 into an account designated by the Administrative
Agent, which funds will be held in such account until such time that the
Interest Escrow Account has been established pursuant to the Interest Escrow
Account Agreement referred to in Paragraph 23 herein and (iv) the Borrower shall
have paid to the Administrative Agent for the account of each Bank that has
executed a counterpart of the Seventh Amendment and delivered same to the
Administrative Agent at the Notice Office on or prior to 4:00PM (New York time)
on April 13, 2001 an amendment fee equal to 0.50% of such Bank's Commitment at
such time.

          29.  From and after the Seventh Amendment Effective Date, all
references in the Credit Agreement and in the other Credit Documents to the
Credit Agreement shall be deemed to be references to the Credit Agreement as
modified hereby.

                                *      *      *

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          IN WITNESSES WHEREOF, the parties hereto have caused their duly
authorized officers to execute and deliver this Amendment as of the date first
above written.

                              HIGHLANDS INSURANCE GROUP, INC.

                              By__________________________________
                                Title

                              THE CHASE MANHATTAN BANK,
                               Individually and as Administrative Agent

                              By__________________________________
                                Title:

                              FLEET NATIONAL BANK

                              By__________________________________
                                Title:

                              BANK OF MONTREAL

                              By__________________________________
                                Title:

                              BANK ONE, NA

                              By__________________________________
                                Title:

                              DRESDNER BANK AG, New York

                              and Grand Cayman Branches

                              By__________________________________
                                Title:

                              By__________________________________
                                Title:

                              BANK OF AMERICA

                              By__________________________________

                                Title:

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