When you choose to start a new game in The Witcher 3, you'll be met with multiple screens, one after another. The first will ask if you want to start the game fresh, or immediately jump into one of its two expansions. Selecting "Fresh Start" will bring up the 'Simulate Witcher 2' screen later.
The second screen asks you to choose your difficulty level, while the third screen determines whether tutorial messages are enabled or disabled.
Finally, the fourth screen asks if you would like to "Simulate Witcher 2 Save". You have two simple options: Yes or No.
Simulating a Witcher 2 save means that you get to decide how several key events played out in The Witcher 2. The consequences of these events can be seen in The Witcher 3. However, you don't get to have your say on these events just yet.
Selecting "Yes" enables additional dialogue choices near the beginning of The Witcher 3. Once you're past the opening tutorial and you've slain the griffin in White Orchard, Geralt will be taken to the palace of the Nilfgaardian Emperor. There, he'll be questioned by General Voorhis.
Voorhis asks Geralt about his past. To be more specific, he asks Geralt about the events that happened in The Witcher 2. Choosing to simulate a Witcher 2 save lets you answer with dialogue options, effectively allowing you to shape Geralt's backstory to an extent.
Selecting "No" when asked if you want to simulate a Witcher 2 save disables these dialogue options, and the game presents you with a set of premade outcomes. These premade outcomes are not necessarily canon — they're just there to get you into The Witcher 3 with less fuss.