That is to say: a mechanic in my game/setting will be invoking a past "event" to modify some in game event. It would almost be akin to a flashback, really: seeing someone in the crowd, and realizing it's a fellow comrade from the Comstock Insurrection, or being in a firefight and realizing it's just like that time you lost Jimmy at Karger IV...

I realized that there are (at least) two ways of doing this: let the players pre-create these memories beforehand, or let them create them off-the-cuff.

A side effect in my game is that each past "event" has some meta-game cost to the player, in either the chance of legal detection or Massive Karmic Vengeance or such. Furthermore, each "event" should have some means of "resolution" - a means of freeing yourself of the confines of this event, but also losing it's value - this may well mean being able to generate another "event" on demand....

Thoughts? Ad Hoc or Pre Fab?

Sometimes off the cuff has a more gritty feel; sometimes I think this is also the perrogative of the GM, to work with the players, get to know their characters... and at times toss them things, and maybe quietly or not so quietly pull them aside and say "this seems familiar" or "wait a moment, you know this guy!" I've never had a problem of creating characters from a PC's past, and in fact often feel more comfortable doing this than trying to work with an NPC of the player's own creation unless I really know that NPC well. Then again, taking a player's NPC and running with them and adding on bits and pieces the player and his character didn't know... can be quite rewarding as well.

Off the cuff, definitely. Because even very design-at-start players will not know everything and may end up feeling attached to a millstone.

Secondly, why is there a cost? Because they might be able to justify a bonus? IMO this the wrong way to go about it; I think this sort of thing has its best effect when the players are eager to flesh out the world and give it life, and I'm perfectly prepared to reward them for doing so. Every time players call on some character anecdote, the other players will appreciate their character better, perhaps more deeply. It's actually a really good way to get the Man With No Name characters to come out of their shells.

Secondly, why is there a cost? Because they might be able to justify a bonus?

I think defining history is karmic anyway, because it sets certain facts in stone. Nobody will detail every day of a characters life so the events that are actually portroyed get rendered into fixed unchallangeable truth. That said I can see an element to this if there is some bigger point they connect to.