Can auto insurance coverage be denied if passenger didn't wear seat belts?

They have what's called "Contributory Negligence". That means that coverage could be reduced by what ever percentage they desire (say 50%) because the passenger failed to take proactive action to reduce or eliminate their injury. You, yourself cannot be sued for the difference for the same reason unless your were negligent in your driving. It would all be ironed out in civil court, if it goes that far.