If you disable option “Allow un-encrypted devices” it means user should encrypt device. In this case, if device isn’t encrypted and enrolled to portal user will be receive notifications with requirement to encrypt device. If device is encrypted by user and user configured his own password then passcode from portal configured by administrator will be ignored on such device. That’s why you see this alert when try to uncheck this option.
I’ve just been looking at this in more depth and can see exactly what @Noiden is on about.
For security we want to nag/alert the user that we want the device encrypted, but we should not have to lose the enforcement of passcodes to do this. This is simply the way you guys apply the policies and needs to be looked at as mobiles need to be able to have both.
We appreciate for providing additional details on this matter. We have opened a Feature Request to have the ability to apply encryption and still retain the passcode action on the devices. Updates will be relayed via this forum post/associated support ticket. Thank you