Encrypting the data transfer between sensor and panel with S-Line sensors means that only the panel will be able to read the status of the sensor transmissions as it has the proper encryption key.
Think of it as the difference between plain text and encrypted text. Someone with the right rf listening equipment could listen to unencrypted sensor transmissions and know the status of doors/windows, and this would give the ability to spoof the signal, repeating the captured transmission, making the panel think the sensor is in one state when it is in another. This is of course more rare than brute force entry, but it is a concern, and a weakness of unencrypted systems.
Encrypted sensors are objectively more secure than unencrypted sensors, and Power G sensors are objectively more secure than S-Line with their added frequency hopping.
An encryption code is synced with the IQ Panel 2 at the time of enrollment. As I understand it, the panel confirms this with the sensor radio. If it is enrolling with a panel that does not support encryption and does not sync this encryption key, it functions as an unencrypted sensor. If enrolled with a Qolsys IQ Panel 2, it only functions as an encrypted sensor.