Haw, I don't think she was REALLY meaning it... but I didn't have a clue how to respond. I felt awkward.
I wouldn't have known how to respond either. I would probably just have given a little fake laugh or something.
I'm not good at insult humour; I'm always afraid I might accidently hit a subject that is sensitive for that person, so I won't insult someone even as a joke. (For example, what if your husband had spent a large part of his life being teased for his looks and as a result had spent loads of money on psychiatry and plastic surgery.)
I once went to visit the home of a woman I met in a dance class in the US, where I met her boyfriend and some of her friends, and all they did the whole time was insult each other - what I would consider to be really nasty insults - the kind of thing that I would hold off saying to someone in a fight because I would be afraid of regretting it later. They obviously got along and didn't take it seriously (otherwise they wouldn't be friends and she and the boyfriend would've broken up a long time ago), but it was just very strange and uncomfortable for me.