What's the lowest level of performing ability for a teacher then?
I would think they should be able to (or in past were able to) develop the skills, create the effect, etc. for a piece. If they've never, ever done the skill, I would wonder why they're teaching it. (Except to start learning it for themselves, using the student as a guinea pig. I've heard of that/seen that/been used like that for academic classes.)
If they've done it in the past -- I'm thinking of the old prof/teacher who once played but could teach someone fairly well. A demonstration doesn't hurt though.
If they haven't played a specific piece, but they've got the style or composer down, great.
If they can do it, and can teach it, that would be the best. If they've never done it, they would be figuring it out/have potentially incorrect/inefficient information, etc. I would wonder about that.