We never been approached or questioned by any muggles, but we use different techniques depending on the cache. Children are always a helpful distraction, reading a map, etc.
Several months ago, I thought about this same question. "How do more experienced cachers handle muggles?" My thought was place a new cache and watch, observe, and question the cachers finding it. As we all know FTFers can be most intense.
Here is what one of our great FTFers said to give you an idea: What a delightful find! Passed another couple as we walked out on the trail. Were they cachers? Can we beat them to the cache? At ground zero we are fiddling around when they pass us again. Hmm, they must not be cachers! WE found the cache, SL and headed up the trail when the same couple is coming back. We stop to chat and they ask if we walk the trails alot. Opa G replies that actually we are playing a game and we go on to tell them about geocaching. I don't know how they kept a straight face as they reveal they are the cache owners, just checking on their cache! It was great! and we chatted caching all the way back to the road! So good to meet you and your caches are super!
Muggles can be anyone, treat them as you would any person you are meeting for the 1st time. Pleasant, polite and ready to explain what you are doing. If all else fails, the cache is not going anywhere come back at a later time!