Why does setting 'simulate physics' on a capsule component result in falling though the ground?

When you set ‘simulate physics’ on the capsule component in the first person template, your character will start falling though the ground.

Do you know why this happens?

You need to enable both physics and collision (QueryAndPhysics) on your object and make sure that you have the correct channel responses set (ignore, overlap, block). Check out this page for more information on those concepts.