The Hawaii Employees’ Retirement System filed a lawsuit in Oahu Circuit Court on Tuesday to block a law providing severance benefits to roughly 1,500 Maui County hospital workers from taking effect.

The state is in the midst of transferring Maui Memorial Medical Center, Kula Hospital and Lanai Community Hospital, which have been operated by the state under the Hawaii Health Systems Corp., to Kaiser Permanente. As part of that transition, the Legislature passed Senate Bill 2077, which would provide either a lump sum cash payment or early retirement to workers who lose their state jobs, regardless of whether they go to work for Kaiser.

Gov. David Ige vetoed the bill, in part, because he said it could risk the tax-exempt status of the ERS, a defined public pension plan. The Legislature overrode the governor’s veto last month.

The lawsuit, initiated by the board of the ERS, claims that the law, now known as Act 1, could be “catastrophic” to the ERS and its approximately 120,000 members, which include current and retired state and county workers.

“The employees would no longer be able to defer the payment of taxes on employee retirement contributions. Rather, the contributions would be included in the employees’ income and taxed as normal wages when contributed,” according to a news release issued by the ERS. “Further, the employees would be subject to federal income taxes on the portion of their benefits funded by the employer at the time the benefits vest, instead of when they actually receive the benefits.”

Employees would also lose the ability to roll over their retirement contributions, tax-free, to other retirement plans, such as IRAs, according to the ERS.

“This is a very extraordinary circumstance from our perspective, and we can’t afford to get this wrong,” Thomas Williams, executive director for the ERS, told the Honolulu Star-Advertiser. “The deleterious impact to our members would be so great that we have every responsibility to avoid it.”

Allowing workers a choice of either taking the cash severance payment or taking early retirement runs afoul of the federal Internal Revenue Code, he said.

“Essentially, we don’t have an issue as to whether the Legislature may allow the selection of severance benefits or a special retirement benefit, especially if the special retirement benefit is funded,” said Williams. “The problem lies in the fact that the individuals affected are given a choice between the severance benefit, which is conceived as a cash benefit, versus early retirement — and that is what is impermissible.”

The lawsuit asks the court to issue an injunction, barring the law from taking effect until the ERS can obtain a ruling from the Internal Revenue Service clarifying the situation.

Sen. President Ron Kouchi said that he had yet to see a copy of the complaint, but that he believes that if the court does find a section of Act 1 to be unconstitutional or improper, then that section could be stricken from the law while the rest would remain in effect.

“I just hope that we get the labor issue resolved as quickly as possible, and we need to ensure that the residents of Maui have the quality health care that they deserve,” said Kouchi.

The ERS is being represented by former state Attorney General David Louie, an lawyer at Kobayashi, Sugita &Goda. The Hawaii Health Systems Corp. is named as the plaintiff in the lawsuit.

“We are not trying to stop the Maui Memorial thing,” said Louie. “And the ERS does not take a position on that. The ERS is not trying to do anything but protect its beneficiaries.”

The state is also entangled in a lawsuit brought by the United Public Workers, which is seeking to halt the transfer of the three hospitals. The Governor’s Office and UPW officials are still trying to negotiate a settlement.

Beyond concerns about the loss of the ERS’ tax-exempt status, the lawsuit stresses the ongoing financial troubles of the public pension plan.

As of June 2015, the ERS managed about $14.4 billion in assets, according to the complaint. But the financial solvency of the plan has been deteriorating since 2000, when 94.5 percent of the plan was funded. As of the 2015 fiscal year, the portfolio had a funded ratio of only 62.2 percent.

The ERS’ unfunded liability stands at about $8.8 billion.

“To put the current financial state of the ERS in perspective, if the ERS were a private sector multi-employer plan covering the members of a union, it would be deemed to be in ‘critical status’ under the Internal Revenue Code,” according to the complaint. The administrator would have to come up with a “rehabilitation plan” and restrict future benefit accruals and eliminate early retirement benefits.

The ERS’ unfunded liability places it among the 11 worst-funded state pension plans in the country, according to the complaint.

Williams said that as for the provisions in Act 1, the cash payouts aren’t expected to affect the ERS, because he expects that they would be funded from a different source, such as general funds. However, the funding has yet to be allocated.

The early retirement benefits are expected to increase the plan’s unfunded liability, however, unless the Legislature comes up with a different mechanism of payment, said Williams.

He noted that in 2011 the state passed a law that bars increases in benefits until the ERS is considered fully funded.

“We want them to honor their prohibition against enhancements,” said Williams. “If they ignore that, I hope that they would at least provide the funding.”