So a secondhand story with no specifics makes the whole process suspect?
I've been using Windows Update since the first day it was available, and I've never had a Windows update force me to reinstall everything. I can think of a few minor issues over the years, but overall, Windows Update has been an overwhelming success.
In the 18 or so years since Windows Update started offering device drivers, I've administered hundreds of computers, and I don't think I've ever seen a situation like you describe. If something like that does happen, it's typically the result of bad or counterfeit hardware.
There is a ton of counterfeit hardware coming out of China, and it's often used in otherwise legit products: for example, a common USB RS232 interface was cloned and sold for a fraction of what the real deal cost. The manufacturer responded by subtly altering the real chip, and the legit drivers specifically look for the cloned hardware and fail to run.
I'm not saying that a WU related failure has never happened... but updating drivers manually also has its share of problems. Trying to do it manually can often get people in to more trouble than they can get themselves out of, especially with generic devices that are implemented slightly differently on different motherboards. This is pretty common with Realtek stuff, for example, where one generic chip gets used in dozens of different configurations. Use the driver for the wrong configuration, and you've ruined the whole audio stack.
Do the same thing with a hard drive controller, and you are going to have real problems.
In my experience, you're far more likely to have problems when manually updating drivers than by letting Microsoft do it for you, and in the situations where MS does mess you up, you can recover in safe mode.