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The "background" you're setting is for after the ipod touch locks itself or you push the lock button, when you have to "slide to unlock" that screen is whatever picture you have set. Unless you're actively listening to a song and then it'll just be the album art to that song.
At this point in time the only benefits to upgrading to 1.1.3 is to be able to install the January apps. 1.1.4 is believed to have set the ground works for the new SDK that is being released for the iPod Touch and iPhone.
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