That is odd here is an example from a test system running 12.04 where I changed the group on my ssh key files and granted the group read:
Code:
hawkmage@vb-ubuntu:~$ ls -l ~/.ssh/
total 12
-rw-r----- 1 root tempuser 1675 Nov 19 19:17 id_rsa
-rw-r--r-- 1 root tempuser 404 Nov 19 19:17 id_rsa.pub
-rw-r--r-- 1 hawkmage hawkmage 3536 Nov 19 19:16 known_hosts
hawkmage@vb-ubuntu:~$ ssh server
Last login: Mon Nov 19 19:20:17 2012 from vb-ubuntu
server:~ hawkmage$
What are the permissions on the key files?
If you want to old less secure functionality you cane add/change the StrictModes directive to the sshd_config file.
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