It seems that this function supports only decryption of password protected archives (see changelog: http://pecl.php.net/package-changelog.php?package=zip). Creation of password protected archives is not supported (they will be created simply as non-protected archives).

Example code for extraction of files from password protected ZIP archives:

<?php
    $zip = new ZipArchive();
    $zip_status = $zip->open("test.zip");

    if ($zip_status === true)
    {
        if ($zip->setPassword("MySecretPassword"))
        {
            if (!$zip->extractTo(__DIR__))
                echo "Extraction failed (wrong password?)";
        }

        $zip->close();
    }
    else
    {
        die("Failed opening archive: ". @$zip->getStatusString() . " (code: ". $zip_status .")");
    }
?>

To create password protected archive in PHP >= 7.2 use:

<?php
    $zip->setEncryptionName('test.txt', ZipArchive::EM_AES_256, 'test');
?>

Based on example from the documentation:

<?php

$zip = new ZipArchive;
$res = $zip->open('test.zip', ZipArchive::CREATE);
if ($res === TRUE) {
    $zip->addFromString('test.txt', 'file content goes here');
    $zip->setEncryptionName('test.txt', ZipArchive::EM_AES_256, 'passw0rd');
    $zip->close();
    echo 'ok';
} else {
    echo 'failed';
}

?>