With the generative AI tools such as ChatGPT being widely used in higher education, the demand for AI literacy and skills to assess more balanced and ethical generated content is increasing. Prompt engineering (PE) as a key knowledge and approach in AI literacy, bridges Large Language Model (LLM) based AI with human-like interactions and instruction is suggested for educators and students. However, there are few studies that systematically discuss the current situation of PE in higher education, especially the challenges and the skills. This review identifies a gap in improving AI literacy related to prompt engineering in higher education. The existing challenges and applications are also being reviewed, an ethical discussion on the prompt engineering framework in higher education, educators’ concerns about AI, and the effective integration into pedagogies are identified. Practical skills such as crafting clear and specific prompts, iterating the prompt refinement, specifying output format, providing contextual information, using examples in prompts, breaking down complex tasks, and experimenting in tone and style are suggested to both educators and students. The AI literacy of fostering AI knowledge, critical thinking, and adaptability is tailored for practicing these skills, providing the future direction of curriculum reforming and professional training.