Even with encrypted VM, VM can be restored by "Replace Disk".
Currently, encrypted VMs are not eligible for "Replace Disk" as described in the following public information.
Title: Restore Azure VMs
Replace existing is supported for unmanaged managed VMs. It is not supported for unmanaged disks, generalized VMs, or for VMs created using custom images.
From the security point of view as well, it is possible that the number of encrypted VMs will increase in the future, so there is a need for an easier recovery method.
Currently, encrypted VMs can only be restored from "disk restores". We should also implement VM restoration with "disk replacement" of encrypted VMs.