I have seen surrounds installed this way...but Ideally it is best to install directly to framing. My guess is you have grout failure that caused moisture to reach behind the tile. In the "old" days tile was often set on green board or even simple drywall. Once wet the substrate itself fails, so the tile is trying to stay attached to mush...this "mush" is still there a simple "cover" of a surround does not treat the cause but merely masks the symptoms. ...»

Loose tile means moisture has got behind the tiles. You should at least remove the bottom area and fix any possible mold that may be present. then If your still interested in doing a surround, you simply need to build up the repaired area with cement backer board to bring the repair up flush with the existing tile. This is also a good time to replace if need be the faucets on the wall as you can open up this area and fix or upgrade before putting the surround in.